Which offers greater flexibility in an uncertain future? You’ll need to withdraw the funds before you’re age 59½. That’s not the case with a Roth, which allows you to invest in nearly anything. The Internal Revenue Service (IRS) considers putting an IRA distribution into a 529 plan as a distribution included in your taxable ordinary income., Beyond the income tax, you would also face an additional 10% tax penalty for the early withdrawal if you are not yet 59½ years old. The 529 plan can also be a useful vehicle for extended family to help pay for college. Young adds: “It is important to remember that the greatest value of a Roth IRA is the power of tax-free compound growth over the long-term. A 529 plan, also called a qualified tuition plan, is a tax-advantaged savings plan sponsored by states, state agencies or educational institutions. A 529 plan is a tax-advantaged account that can be used to pay for qualified education costs, including college, K-12, and apprenticeship programs. Be sure to consult with your tax advisor before making any decision. Accessed Aug. 19, 2020. You should visit the IRS website to get a full breakdown of the exempt qualified higher education expenses., Remember, the higher education expense would exempt you from the 10% penalty, but the distribution would still incur the ordinary income tax. In addition, the distribution may need to be included as income on any financial aid applications, especially the Free Application for Federal Student AID (FAFSA), so be sure to time it carefully., There are two types of 529 plans: prepaid tuition plans and savings plans.. Beginning in 2019, each year individuals may contribute up to $6,000 into a Roth IRA ($7,000 for those aged 50 and above). “Withdrawals from a Roth IRA would count as income for the FAFSA form even if it is not taxable, which would have a significant impact on future eligibility.”. (That’s in contrast to a traditional IRA, where the tax break comes today.) I am a nationally recognized award-winning writer, researcher and speaker. U.S. Securities and Exchange Commission. Traditional IRA vs Roth? The Roth IRA allows you to contribute a maximum each year – $6,000 in 2019, and an extra $1,000 catch-up contribution for those over 50. "Retirement Topics - Exceptions to Tax on Early Distribution." Savers don’t get an immediate tax benefit from the federal government for contributing to the plan, since contributions are made on an after-tax basis. You want greater flexibility in investment options. Meanwhile, the Roth IRA “is generally beneficial for education savings when the saver is unsure of the intended use of the funds or needs to save for multiple goals in one account.”. Looking for advice... Retirement. And if they’re overfunded, “these accounts can be rolled to a 529 plan for the benefit of other family members.”, [READ: Get tips and advice on student loans]. You have a 401k(k) Roth option and you want to contribute more than $15,000 per year. Note that this caveat applies only to the earnings in a Roth IRA, not the contributions, says Morris Armstrong, founder of Morris Armstrong EA. What are the rules regarding withdrawals for each savings vehicle? You don’t have to be a scholar to understand that college is expensive and only becoming even more so. Our experts have been helping you master your money for over four decades. A tax-deferred savings plan is an investment account that allows a taxpayer to postpone paying taxes on the money invested until it is withdrawn in retirement. This is an important consideration when comparing 529 plan options as some states may force the 529 plan into investments that may be too conservative given the objectives of the 529 plan owner. The offers that appear on this site are from companies that compensate us. Unlike Roth IRAs where contributions can be made up to April 15th of the following year, however, the Roth 401(k) contribution must be made by December 31st of the tax year to which it applies. In addition, the contribution limits can be higher for 529 plans than they would be for an IRA. However, if you use your Roth IRA funds to pay for the qualified educational expenses, those funds may be included as income for the purposes of the student’s financial aid calculation. If married, each grandparent (and parent) can contribute up to $15,000, for a total of $30,000 per couple. Very wealthy families can even frontload 529s by contributing five years of gifts ($75,000 per giver/per child) at once, to allow maximum time for earnings growth. “A Roth IRA is designed to be a retirement savings vehicle, where a 529 plan is specifically designed to be a higher education savings vehicle,” says Robert Farrington, CEO of The College Investor, San Diego, California. Bankrate is compensated in exchange for featured placement of sponsored products and services, or your clicking on links posted on this website. 529 Plan vs. Roth IRA—How to save for college Advertiser Disclosure This article/post contains references to products or services from one or more of our advertisers or partners. Contributions grow in a tax-free environment. There are no income requirements for contributing to a 529 plan. Unlike money from a Roth IRA, though, using 529 plan funds won’t count as income for determining financial aid. “We do not recommend that our clients use a Roth to fund education expenses unless they have exhausted other options, such as a 529 account or non-retirement assets,” says Young of RMB Capital. Roth IRAs fall under federal regulations. When one drills down into the specifics of each option, differences become more apparent. Bankrate follows a strict editorial policy, so you can trust that we’re putting your interests first. Note that Roth 401(k) plans can accept up to $19,000 ($25,000 for those aged 50 and above). © 2020 Bankrate, LLC. Another benefit is that grandparents (and parents) can contribute up to $15,000 (in 2019 and 2020) to a 529 plan per child annually without incurring gift taxes. With a 529 plan, you’re limited to the investment options offered by your state’s program. All reviews are prepared by our staff. These include white papers, government data, original reporting, and interviews with industry experts. You’re not sure if you’ll be needing the money for qualified educational expenses or that such a need will exceed the amount contributed. Each state imposes its own investment guidelines regarding their 529 plans. The content created by our editorial staff is objective, factual, and not influenced by our advertisers. Therefore, this compensation may impact how, where and in what order products appear within listing categories. “Families applying for financial aid under the federal methodology will want to keep in mind that Roth IRAs are not reported as an asset on the Free Application for Federal Student Aid form,” says Mahaney. The Roth 401(k) does not have any phase-out provision. You want to shield as much of your assets as possible from inclusion in financial aid calculations. Invesco. © 2020 Forbes Media LLC. Who are the primary beneficiaries of each plan? Those are the biggest positives of such plans, but 529 plans also offer an advantage over the Roth IRA, especially for parents who are on the younger side. You think you may need the money for non-qualified educational expenses. It can also be used for vocational and trade schools. So, whether you’re reading an article or a review, you can trust that you’re getting credible and dependable information. This compensation may impact how and where products appear on this site, including, for example, the order in which they may appear within the listing categories. You expect to qualify for a large financial aid package because of your present income situation. Any estimates based on past performance do not a guarantee future performance, and prior to making any investment you should discuss your specific investment needs or seek advice from a qualified professional. In general, Roth IRA contributions (i.e., not the gains on those contributions) can be taken without tax consequences.
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