College is expensive and the cost continues to rise each year. As a parent, you want to be prepared and start saving for this expense early. There are a few tax-smart options to consider when saving for this expense – a Roth IRA or 529 plan. When you utilize an account that offers a tax break, you have the ability to stretch your money further. There are pros and cons for both of these options. Review the details to help decide which account would work best for you and your family.
The Roth IRA was created to encourage people to save for retirement. The difference between a Roth IRA and other traditional retirement accounts is the ability to withdraw contributed money any time, free of taxes and penalties.
529 plans are similar to Roth IRAs but were intended for people to save for college instead of retirement. As long as the money withdrawn from the plan goes to qualified education costs, you will not owe taxes or penalties.
While you are able to withdraw contributed money, keep in mind that you will owe taxes and a 10% penalty on any investment earnings you take out of this account before age 59 ½. However, an exemption could work in your favor. If you withdraw money to pay for qualified education costs, you will not owe the 10% penalty, but you will still owe taxes on any investment earnings withdrawn.
Many people prefer the Roth IRA because of the flexibility and variety of investment choices. If you aren’t 100% sure your children will attend college, this may be option for you. That way, you can save the money now and decide what to utilize it for later.
While you will owe taxes when withdrawing investment earnings from a Roth IRA to pay for qualified education costs, you will not face the same dilemma with the 529 plan. However, if you withdraw money from a 529 plan and it goes to another purpose other than education, you will owe both taxes and a 10% penalty on investment earnings. With this being said, it may seem like the Roth IRA is the way to go just in case your child decides to forgo college. Here are a few more factors to consider:
- Does your state offer a 529 tax break and a good 529 plan option? The deduction or credit is like free money.
- Are you going to need financial aid? Roth withdrawals generally count as income when completing the Free Application for Federal Student Aid (FAFSA). Having more income translates into receiving less aid.
You should always consult a professional before making any financial decisions. We can help. Contact us today!