All Sections

Home | Marc A. Hebert's Money Sense

Marc A. Hebert's Money Sense: Saving for college -- Section 529 plan or a Roth IRA?

June 23. 2018 9:00PM
 (Metro Creative Connection)

It is hard to believe, but it was way back in 1996 that Section 529 Plans were created. They were designed to give people a tax-advantaged way to save for college. Subsequently, in 1997, Roth IRAs were created. These were tax-advantaged vehicles as well. Roth IRAs, however, were created to help people save for retirement.

The amazing thing is that some people can actually use either or both as college savings tools.

Section 529 Plans are funded with after-tax dollars that accumulate earnings tax-free. Qualified distributions are tax-free. Qualified means that the funds are used for an eligible college or K-12 education expense.

While there is no federal income tax deduction for contributions to Section 529 Plans, there may be a state income tax deduction. Check with a tax adviser for the rules in a particular state.

Roth IRAs are similar. The Roth is funded with after-tax, nondeductible dollars. Earnings accumulate tax-free. Qualified distributions are tax-free. Distributions are qualified if the funds have been held for at least five years and one of the following situations apply:

. Over age 59½

. Death or disability

. Qualified first-time home purchase

When a college tuition bill is due, some parents have chosen to pay with their Roth IRA money. This works well if the distribution is qualified. But what if the parent doesn't meet the qualified distribution rules? Roth funds can still be used, but there might be taxes and penalties on any earnings included in the distribution. Note that original contribution amounts absent any investment earnings can always be withdrawn from a Roth IRA tax and penalty free.

Section 529 plans have distribution rules too. If the funds are used for any purpose besides qualified education expenses, there could be taxes and penalties on these distributions.

The next question parents usually ask is how financial aid is affected. Roth IRAs aren't counted as assets on the Free Application for Federal Student Aid (FAFSA). As the money is withdrawn, however, it could be counted as untaxed income.

Section 529 Plan assets do count as a parental asset on the (FAFSA) for dependent students. This is true whether the Section 529 Plan is owned by the parent or the student. A smaller percentage of a parent's assets versus a student's assets are counted in calculating the Expected Family Contribution for paying college expenses. Qualified withdrawals from 529 accounts are excluded from federal income tax and, as a result, do not have to be added back to base-year income for the FAFSA. This favorable treatment does not extend to plans owned by grandparents or other relatives.

Colleges may use other aid forms, such as the CSS Profile, so check to see how the college treats both types of accounts when applying for financial aid.

Another difference between the account types is the available investment choices. Section 529 Plans are limited to the investment options that the plan offers. The plan owner is allowed to change the investment choices for existing contributions twice per calendar year and move the entire plan to another state's plan once in any 12-month period. Be certain to review the costs of the investments within the plan.

On the other hand, Roth IRA money can be invested in just about anything, such as stocks, bonds, ETFs, or mutual funds. Once again, review the investment costs.

One final difference is that while anyone can contribute to your 529 account, not everyone can contribute to your Roth IRA. You must also have earned income to contribute to a Roth IRA. Roth IRAs have additional eligibility rules that need to be reviewed each year.

So why use either to save for college? The tax breaks reduce the cost of saving. Flexible withdrawals and potential retirement savings can make the Roth a better choice. There are other ways to pay for college, but retirement has more limited choices. If college is a definite, then the 529 plan might be a better choice.

Marc A. Hebert, M.S., CFP, is a senior member and president of the wealth management and financial planning firm The Harbor Group of Bedford. Email questions to Marc at Your question and his response might appear in a future column.

Business University

More Headlines