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Roth IRAs and 529 savings plans are great for saving for college – both are pre-taxed so you can withdraw the investment after it has grown much larger due to compound interest without being charged with a huge IRS bill. But which one is better? As with most decisions affecting your portfolio, they are each a tradeoff, as Roth IRAs offer more flexibility in how the money can be spent, while 529s have higher contribution limits that can maximize savings. Here are a few other factors to consider.
The pros and cons of Roth IRAs
Roth IRAs were created for retirement, but unlike other retirement accounts like 401 (k) s, your contributions are taxed up front which means you won’t be taxed later when the entire investment is withdrawn. The only catch is that you have to wait until you are 59½ years old before you can withdraw these funds, which can be used for whatever you want (as opposed to 529 savings plans that have fines if you don’t use for educational purposes editions). On the other hand, you can withdraw funds that you have contributed (ie that you have paid in – without any profits from your investments) at any time without tax or penalties, without waiting for the age of 59½ years.
Benefits of Roth IRAs
- Your contributions (not earnings) can be withdrawn at any time without penalties or taxes.
- From the age of 59½ years, all money can be withdrawn tax-free and without penalties, provided the account has been open for at least 5 years (otherwise you may owe income tax on your income).
- There are no 10% penalty for the advance withdrawal of all of your income if the money is used for qualified training costs, although you still have to pay income tax on it.
- If you don’t need all of the money for education, the rest can be used for retirement.
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Disadvantages of Roth IRAs
- You will likely owe income taxes and a 10% early withdrawal penalty before you are 59½ years old (although, as noted above, the additional 10% penalty is waived if you use the money on skilled education expenses). Even past this age, you may still owe taxes and fees if the account has not been open for at least 5 years when making a withdrawal.
- There are income limits and the amount you can deposit will expire if you earn more than $ 125,000 for individual applicants or $ 198,000 for joint applicants (you are completely ineligible to contribute if you are earn more than $ 140,000 and $ 208,000 respectively).
- The tax implications of applying for study grants are not favorable as withdrawals count as study grant income, which can have a negative impact on the amount of the grant.
- Unlike 529 savings plans, Roth IRA contributions cannot be deducted from your state taxes.
- The annual fee is low compared to 529; You can only contribute up to $ 6,000 ($ 7,000 if you are 50 years old or older) in 2021.
The pros and cons of 529 savings plans
A 529 plan is specifically designed as an Education Saving Fund, so it is limited to qualified educational expenses such as textbooks and tuition fees (unless you want to pay tax and a 10% fine) Unlike a Roth IRA, you don’t have to wait until you are nearly 60 years old to make withdrawals.
advantages of 529 savings plans
- There are no income or age limits for withdrawals.
- There are no taxes on withdrawals that are used for qualified training costs.
- Contributions to your 529 are tax-deductible at the state level.
- There is practically no limit to the contributions you can make per year, although there may be a lifetime limit. depending on the state (usually around $ 500,000).
- You can change or transfer beneficiaries.
Disadvantages of 529 savings plans
- Less flexibility – you have to use the money for its intended purpose or pay a fine to get it back.
- The investment options are generally more limited than with Roth IRAs.
- The plans are each tied to a single beneficiary, which means you’ll need to set up a separate account if you want to save for more than one child.
Which College Investment Plan Should You Choose?
When choosing between a Roth IRA and a 529 savings plan, the best option depends on what is important to you: flexibility in using your investment or flexibility in using your investment. 529s allow you access to tax-free money at a much younger age, but you run the risk of being taxed and punished if your school plans fail, which a Roth IRA doesn’t. There are also tax and income considerations to consider as contribution limits for Roth IRAs may not suit your specific needs.