Roth IRA's vs. 529 College Plans
College tuition fees for your children constitute a sizeable chunk of your life’s earnings. Arriving at a figure for an education fund is a tricky affair, because you have no idea which college and what course, if any, your children will be taking. Best you can do is take the National average for college education ( $4,694 per year for Public Universities and $20,000 for Private Colleges as of 2006 ) and adjust for inflation ( 8% ) based on the year you expect a child to enter college.
Federal and state legislation has enabled parents to set up education funds which deliver a string of benefits to enhance savings specifically meant for education. As of now, the two best choices for an education fund are Roth IRA’s and state sponsored college savings 529 plans. The central question still remains. Which is the best way to save money for the children’s education? For purposes of this discussion, we limit ourselves to the relative merits and downsides of Roth IRA’s and 529 plans as educational funding vehicles.
The state-by-state 529 plans offer a clear benefit – No taxes. 529 plans allow you to make massive contributions, with both contributions and gains in the account being tax deferred. When it’s time to start doling out the college tuition fees, and you withdraw the funds, that is also entirely tax free. In effect, both contributions and gains are totally tax free – As long as the funds are used only for the specified educational purpose. If your child decides to opt out of further education, and you have no choice but to use the funds for other purposes, you are left holding a massive investment which is about to be piled on with all kinds of taxes and penalties. Another downside for 529 plans is that the scope of investments for the funds is rather narrow.
This is where a Roth IRA used as an education savings fund can come in handy. It provides a high degree of flexibility in terms of both investments and the withdrawal and ultimate use of the savings. The IRS does have restrictions in place for Roth IRA’s including annual contribution limits and period specific considerations for tax free withdrawal of contributions and earnings.
Another factor which needs to be taken into account is your eligibility for federal aid. Contributions and savings in Roth IRA’s are not considered as assets if and when you apply for federal aid. Thus, while state 529 plans offer enhanced tax benefits for a college fund, the rules governing the plans are fairly rigid and restrictive. Not so with Roth IRA’s which offer greater flexibility and are adaptive to any changes in your future plans. You are advised to consult your financial planner and discuss all the options with your family before you make any decision regarding setting up an educational fund.