Should I Use a Roth IRA Instead of a 529 to Save for Education?

Education costs have skyrocketed in recent years, and the trend shows no sign of slowing down. According to U.S. News & World Report*, the average cost for tuition and fees in the 2023-2024 school year is:

• Private Colleges: $42,162 per year
  

• Out-of-State Public Universities: $23,630 per year
  

• In-State Public Universities: $10,662 per year

Now, fast forward 18 years—when your child may be ready for college—and brace yourself for some eye-popping numbers (adjusted for inflation):

• Private Colleges: $196,154 per year
  

• Out-of-State Public Universities: $109,936 per year
  

• In-State Public Universities: $49,603 per year

With education costs rising faster than inflation, it’s more important than ever to think ahead about how to save. One option many people consider is the 529 College Savings Plan. But what if you could tap into another powerful investment tool—the Roth IRA—to fund your child’s education? In this post, we’re going to take a closer look at the benefits of using a Roth IRA for education savings.

First Things First: What’s the Difference?

Let’s start by defining these two investment vehicles:

• Roth IRA: A Roth IRA is a retirement account where you contribute after-tax income. You don’t get a tax break on the contribution itself, but once your money is in, it grows tax-free, and you can withdraw it tax-free once you’re 59 ½ or older. The contribution limit for a Roth IRA in 2024 is $7,000 per year.
  

• 529 College Savings Plan: A 529 plan is specifically designed for education savings. You can withdraw money from a 529 tax-free to cover tuition, room and board, fees, and other eligible education expenses for kindergarten through graduate school. The contribution limit for a 529 plan is tied to the IRS annual gift tax exclusion—$18,000 per individual in 2024.

Why Consider a Roth IRA for Education Savings?

When it comes to saving for your child's future, the Roth IRA offers several advantages over a 529 plan. Let’s break it down:

1. Lower Costs

Roth IRAs tend to have significantly lower fees compared to 529 plans. At most low-cost brokerages, you can find a Roth IRA with an expense ratio as low as 0.02%, while a 529 plan might have an expense ratio of 0.14%. Over time, those small differences in cost can add up and make a big impact on your savings.

2. Flexibility With Withdrawals

Here’s where the Roth IRA really shines: flexibility. While 529 plan withdrawals are generally restricted to education-related expenses, you can take out your Roth IRA contributions (not the earnings) at any time, tax and penalty-free, for any purpose. If your child needs a car for college or a study abroad trip, you could use your Roth IRA to cover those costs. A 529 plan doesn’t offer that level of freedom.

What if your child decides not to attend college? With a Roth IRA, you can simply keep the money for your retirement or repurpose it for another goal—like helping your child buy their first home or even start a business. In contrast, if you don’t have a designated beneficiary to transfer the 529 plan funds to, you’d face a penalty for withdrawing the money for non-education purposes.

3. No Impact on Financial Aid

Unlike 529 plans, which are counted as assets on the FAFSA (Free Application for Federal Student Aid), Roth IRAs are not. This could mean your child is eligible for more financial aid, grants, and scholarships, as the Roth IRA balance won’t reduce their financial need. This is a significant advantage if your family is counting on federal aid for college costs.

So, What’s the Verdict?

Ultimately, the decision to use a Roth IRA or a 529 plan to save for education depends on your unique financial situation. A Roth IRA might be the right choice if you value flexibility and low costs. But a 529 plan also has its benefits, especially when it comes to education-specific tax breaks and large contribution limits.

In the future, I’ll dive into the reasons why you might still choose a 529 plan over a Roth IRA for your child’s education.

In the meantime, if you’re looking for personalized advice based on your financial goals, I offer free tax strategy sessions to help you navigate the best savings option for you and your family.

Book your no obligation consultation here!

*Source: Nasdaq "How Much Does It Cost To Attend One of 2024's Best Colleges?