How to Choose Between a 529 Plan and Roth IRA

How to Choose Between a 529 Plan and Roth IRASo, how do you choose the right account for your specific needs? There are a lot of variables to consider, but here are some general rules of thumb.
If you’re not on track for retirement yet, go with the Roth IRA. Retirement is a more important goal and this way the money will be available for either purpose.
If you’re not sure that you want to use the money for college, go with the Roth IRA. It’s a more flexible account that allows you to use the money for a variety of reasons without penalty.

If you’re 100% sure that you want to save this money specifically for higher education, go with the 529 plan. The tax benefits and high contribution limits make it the best option for money that’s dedicated to that purpose.

Sacrificing Valuable Retirement Space

Sacrificing Valuable Retirement Space
You risk sacrificing valuable retirement space when you use a Roth IRA for college savings.

If your retirement is 100% covered by other accounts, then this isn’t a big deal. But if not, be careful not to count this money as being available for both retirement and college. It can only be used for one, and when push comes to shove retirement should usually get the nod.

For example, remember above when I said that you can withdraw

For example, remember above when I said that you can withdraw up to the amount you’ve contributed to a Roth IRA at any time without tax or penalty? That’s still true, but it WILL be counted as income on your FAFSA application, which will likely hurt your child’s chances for financial aid.

One way around this is to simply wait until your child’s last year of college to withdraw money from a Roth IRA, but of course you may need the money before then. And even if you don’t, that strategy could hurt a younger child’s financial aid eligibility.

Just know that if you are applying for financial aid, you need to be very careful about withdrawing money from a Roth IRA.

Potential Financial Aid Trap

Potential Financial Aid Trap
While the money inside of a Roth IRA is not counted toward financial aid, withdrawals from a Roth IRA are counted. And those withdrawals can have a big impact.

Most people worry that saving money will hurt their financial aid eligibility, but the reality is that your income will have a much bigger impact. According to SavingforCollege.com, only 2.6% to 5.6% of your savings is counted on the FAFSA while 22% to 47% of your income is counted.

And for financial aid purposes, 100% of withdrawals from a Roth IRA and other retirement accounts count as income, even if the money isn’t taxed as income.