529 vs. Roth IRA: Which Should You Choose for College Savings?

The idea of saving for college can cause analysis paralysis. You have many options to consider when figuring out how to pay for the huge costs of your child’s college education. You’ve likely heard that 529 plans and Roth individual retirement accounts are both tax-advantaged options worth considering.

But when you compare a 529 vs. Roth IRA head-to-head, which comes out on top? As you’d imagine, the decision is complex and depends on your circumstances. Here’s what you should know so you can make the right choice for your family.

How a 529 works

529 plans offer a tax-advantaged way to save for future education costs. The earnings from a 529 plan are not taxable as long as you use the money for qualifying higher education expenses or tuition for elementary or secondary schools. If you withdraw earnings for a non-qualified expense, they’ll be subject to a 10% federal tax penalty as well as regular federal and state income taxes.

It’s worth noting that you typically won’t get a deduction for 529 contributions. However, your state could potentially provide a tax deduction or tax credit for contributing to your state’s 529 plan, assuming they have an income tax. Each state has different rules around how 529 plans work. Check with your state before assuming these tax benefits exist.

Although the IRS doesn’t set annual contribution limits for 529 plans, states might cap the amount of money you can have invested in their plans. This limit usually falls in the range of $200,000 to $500,000 per beneficiary.

Two types of 529 plans currently exist, prepaid tuition plans and education savings plans. Prepaid tuition plans allow a person to buy units or credits at certain participating colleges or universities in the same state. The benefit is locking in the current tuition rates, but you can’t use the purchases to pay for future room and board costs. These plans often have many restrictions, including residency restrictions.

Education savings plans are the more popular 529 plan type. These plans allow you to invest the money you plan to use for future qualifying education expenses. They let you use the money you invest to pay both tuition and room and board expenses. In addition to college expenses, you can use these plans to pay for up to $10,000 of qualifying K-12 private school tuition per year per beneficiary.

Each state offers its own 529 plans, though you aren’t required to choose the plans offered by your state. Picking a particular state’s plan can impact your savings in a few ways. First, each state’s 529 has different fees, costs, and investment choices associated with it. Some investment options have lower returns or higher costs, which would leave less money for the plan’s beneficiary. If you aren’t receiving any state tax benefits, choosing the best plan may come down to which offers the best investment options at the lowest costs.

Pros of 529 plans for college

• Tax benefits: You can withdraw money, including earnings, from 529 plans both tax-free and penalty-free if you use it to pay for qualified educational expenses. This tax benefit could help put more money toward education costs.
• Locked-in rates: If your state has a prepaid tuition plan, you can lock in future tuition expenses at today’s rates. Considering higher education costs traditionally increase faster than inflation for nonprofit schools, locking in today’s prices could potentially save you quite a bit of money.
• No annual contribution limits: Although state 529 plans may have an overall limit to the account’s balance, there is no annual contribution limit. This gives you more flexibility to fund the education costs when you have money available to do so.

Cons of 529 plans for college

• Must plans use withdrawals for qualifying education expenses. You can use money in a 529 plan only for specific things. If you do not use the funds for qualifying education expenses, you must pay taxes on the earnings withdrawn and a 10% federal income tax penalty. Your state’s tax laws may result in other consequences, as well. If your children decide not to attend college and you have no other qualifying educational expenses to use the money on, your investments could take a hit when you remove them from the plan.
• Certain 529 plans could hurt financial aid eligibility. If a person other than the student or parent owns the 529 plan, distributions from that 529 plan could hurt a student’s financial aid eligibility. Although the 529 won’t get reported as an asset on the FAFSA (Free Application for Federal Student Aid) form, income from the plan’s distributions is attributed to the student.

How a Roth IRA works

A Roth IRA is technically a retirement account, but a rule lets you use funds from it to pay for qualifying education expenses. With a Roth IRA, you contribute after-tax money, which means you don’t get a tax deduction for contributions. In 2024, you can contribute up to $7,000 to a Roth IRA as long as you don’t exceed the income limits for your situation. Those age 50 or older may be able to contribute an extra $1,000.

Earnings in a Roth IRA may be subject to a 10% tax penalty if you withdraw them before you reach retirement age, though you can withdraw your own contributions without penalty. However, if you withdraw the earnings portion of your Roth IRA to cover certain qualifying expenses, you may not need to pay income taxes or penalties on the withdrawals.

In particular, you can avoid the Roth IRA’s 10% early withdrawal penalty if you’ve had the account more than five years and you meet the qualifying educational expenses exception requirements. To do this, you can withdraw only up to the qualifying education expenses paid in the year. The costs must be for you, your spouse, children, or grandchildren.

For a Roth IRA, qualifying educational expenses include tuition, books, fees, and supplies. Room and board expenses qualify if the student is at least a half-time student. These expenses must be incurred by a student attending a qualifying educational institution. These institutions must participate in the U.S. Department of Education’s student aid program.

You can open a Roth IRA at any financial institution or online broker that offers one, including Wealthfront. This allows you to find an account that provides the investment options you want at a cost that aligns with your budget.

Pros of Roth IRAs for college

• Tax benefits: You don’t get an upfront deduction for contributions to a Roth IRA. That said, you may be able to withdraw qualifying distributions tax-free, including qualifying educational expenses.
• Choose where you invest: With Roth IRAs, you have many more investment options than you’d get with a 529 plan. Because you can open a Roth IRA with any brokerage firm you choose, you should be able to find suitable low-fee investments that meet your investment goals.
• Flexibility for future uses of money invested: Roth IRAs don’t limit the future use of your money to qualifying educational expenses. These accounts are also good retirement savings accounts. Once you reach age 59 1/2, you can usually withdraw the money tax and penalty-free for any reason you wish.

Cons of Roth IRAs for college

• No state tax benefits: Roth IRAs don’t offer any state income tax deductions or tax credits like 529 plans may. If you live in a state that doesn’t provide these benefits for 529 programs or doesn’t have a state income tax, this drawback of a Roth IRA compared to a 529 plan doesn’t apply to you.
• Limited contribution amounts: Roth IRAs have annual contribution limits. This hinders your saving efforts for both future educational expenses and retirement. If you choose to use your Roth IRA for educational expenses, you may hurt your odds of a successful retirement. Using a 529 plan would allow you to keep your retirement money separate so you can clearly see how much you have saved for each goal.
• Can impact financial aid: Money withdrawn from a Roth IRA to fund educational expenses counts as income on a FAFSA form. This could potentially hurt a student’s financial aid prospects.

529 vs. Roth IRA: Which is the better option?

Choosing between a 529 plan and a Roth IRA for college savings can feel overwhelming. Here is when one savings vehicle could potentially be better than the other.

When a 529 may be the better option

529 plans may work well for your situation if you’re sure a family member will need money for qualifying education expenses in the future. These plans provide additional benefits if your state offers a tax deduction or tax credit for contributions to its plan. Even if the intended beneficiary doesn’t attend college, you have the option to change the beneficiary to specific people within the same family.

Prepaid tuition plans can help lock in today’s prices if you’re sure a beneficiary will attend a participating school. Education savings plans provide more flexibility for those who know education expenses will exist but have not yet determined where the future student plans to attend college.

When choosing a Roth IRA might be right

A Roth IRA is a tax-advantaged account that provides your family more flexibility if you’re unsure of the need to pay future educational expenses, as long as you qualify to make contributions to this account type. If you’re planning to use a Roth IRA for college savings, there’s a risk you may not have enough funds set aside for both retirement and educational expenses.

Even so, the flexibility may be worth the risk for some families that traditionally take other career paths, such as running a family business. You may be able to reduce the risk of not having enough tax-advantaged contribution options if you have access to other tax-advantaged retirement accounts, such as a 401(k).

FAQs

The bottom line

Roth IRAs and 529 plans offer tax advantages to help you save for future education costs. 529 plans are less flexible but don’t have annual contribution limits. Roth IRAs allow you to use the money for non-education-related uses, but you can only contribute $7,000 per year to these accounts unless you’re age 50 or older (then it's $8,000).

Ultimately, deciding how to invest money for college costs is tough. Certain accounts can impact the FAFSA which could lower any financial aid a student may otherwise receive, so that’s an important consideration. Your tax planning needs, circumstances, and goals will also likely influence your choice. Consulting a fiduciary financial advisor could help you consider all aspects of your situation to determine which college savings plan works best for your family.