If you’re a parent, you want the best in life for your child. That includes seeing them go to college. To pay for tuition, books, labs, and other expenses, you have several options for financial assistance. One of these is using a 529 College Savings Plan.
Considering that the cost to attend college continually increases, the sooner you start putting money aside, the better. A 529 College Savings Plan, also referred to as a “qualified tuition plan,” is one possibility to help you save money. Although certain aspects of this plan vary by state, overall, you can grow the funds tax-free. In most states, the contributions can also be deducted from state income taxes.
While a 529 College Savings Plan offers several benefits, it also has a few drawbacks. As an example, your child could later forfeit financial aid if you choose a 529 plan. Depending on your circumstances, that could prove costly. Remember that you have several workaround solutions for this, but before choosing a 529, you should look at all your savings options.
Roth IRA
One other possibility is a Roth IRA. While most people open this type of account to save for retirement, it works for a college education. A nice benefit is that it’s more flexible than a 529 College Savings Plan. Although a Roth IRA doesn’t offer the same tax deductions as the 529 plan, it’s still a great way to help put your child through college.
With a Roth IRA, you can withdraw funds without a tax penalty, whereas you can’t with a 529 College Savings Plan. Now, if you pull money out of a 529 plan and use it for non-college-related expenses, you will need to pay standard taxes and a 10 percent penalty on the associated earnings. This is particularly important to know if your child is getting a higher education but not a college degree.
Another factor has to do with the location of the college your child wants to attend. In California, Delaware, Kentucky, Maine, New Hampshire, New Jersey, North Carolina, or Tennessee, a Roth IRA is a much better solution than a 529 plan. That’s because these eight states don’t provide tax breaks for 529 plans.
Best Time to Start a 529 College Savings Plan
To get the most out of a 529 College Savings Plan, start one when your retirement fund reaches its maximum. Remember, you’re limited to the amount you can contribute annually with a Roth IRA. In comparison, many 529 plans don’t have contribution limits.
That means you could save $200,000 or $300,000, enough to cover your child’s full college education. However, if your child doesn’t want to go to college, you’ll likely get hit with a hefty penalty. The reason is the money wouldn’t go toward its intended purpose.
This is why it can make sense to instead start a Roth IRA after maxing out your retirement plan each year.
Additional Alternatives to Using a 529 College Savings Plan
Besides a Roth IRA, other alternatives to a 529 College Savings Plan exist. Here are some other ways to put money aside.
- CDs – Formally called Certificates of Deposits, this is an excellent way to save money for multiple purposes, including college. In particular, consider the EE Bond type of CD. Since it’s intended to pay for higher education, you could qualify for tax exemptions.
- Brokerage Account – If you anticipate saving money for years to go toward your child’s college education, consider a brokerage account. This works very similarly to a conventional savings account, with the exception that you would need to go through a broker. Unfortunately, there are two drawbacks. First, brokerage fees are sometimes high. Second, this type of account doesn’t offer any tax advantages.
- Coverdell Education Savings Account – In some ways, this savings account resembles a 529 College Savings Plan. The main difference it’s for low-income individuals. Although this too is a great option, you can only contribute $2,000 annually.
What It All Means
To help your child pay for college in the future, you want to start saving money as soon as possible. Also, along with a 529 College Savings Plan, you have options like a Roth IRA, although this has stiff limits as to what you can contribute.
Before making your decision, look at the details of every option. Even better, sit down with a financial advisor who can help you select the best savings solution for you and your child’s specific needs. You can also start by running some free calculations using a 529 plan calculator.
Many do-it-yourself types are using online financial planning software to run scenarios like this. They are using software such as WealthTrace to help them determine whether or not a 529 College Savings Plan makes sense, if they should instead put money in an IRA, or if they should do something completely different like pay down their debt.
It is very important to figure these things out before contributing to a new type of investment account. It could mean thousands of dollars gained or lost over the long run.
