Should I Save for College in a 529 or a Roth IRA?

We applaud every family that makes saving for college a financial priority, as there are so many demands on our resources when raising children, and it's easy to push our college savings plans to the backburner. But it's helpful to remember that every dollar saved is one that won't need to be borrowed later on, and saving early provides the opportunity for significant compound interest (earning money on your earnings!). So once you've committed to saving for college, where should you invest those funds? Many families have heard about 529 plans, the tax-advantaged accounts designed for college savings. But we sometimes get the question about saving for college in a Roth IRA. Is it a good idea? Let's compare the two.

529 Accounts

529 college savings plans get their name from Section 529 of the Internal Revenue Code (IRC), which allows for the existence of tax-free savings vehicles for education costs. They were specifically designed to help families save for college, and are managed by states. Here are the main features of 529 plans:

• Taxes: Earnings grow tax-deferred, and distributions aren't taxed when used for qualified education expenses.
• Tax Benefits: In Massachusetts, those who save in a designated college savings account, such as a 529, can claim a MA state income tax deduction of up to $1,000 for single filers and $2,000 for married persons filing jointly.
• Contributions: 529 accounts are funded with after-tax dollars.
• Investing: Many 529 plans offer investment options that take into account the age of your child and the years remaining until college, becoming less risky as the college years get closer. This allows families an easy way to invest their savings without having to make detailed investment choices.
• Annual and Maximum Limits: Most 529 plans don't have annual limits, though any amount given over $18,000 (the 2024 threshold) is subject to gift tax. There's also an option to give up to $90,000 in one year and treat it as if it were spread over the next five years. States set each 529 plan's maximum contribution limit; the Massachusetts 529 plan, the U.Fund, has a maximum contribution of $500,000.
• Financial aid impact: The value of a 529 account is considered a parent asset on the FAFSA, which has a minimal impact on financial aid eligibility. And a withdrawal from a 529 account for college costs won't have any impact on the student's financial aid eligibility.

Roth IRAs

A Roth IRA is an account designed to help individuals save for retirement. It allows owners to take distributions tax free as long as certain stipulations are met. Here are the main features of Roth IRAs in regards to using funds for college costs:

• Taxes: If you withdraw funds from your Roth IRA to pay for college, any amount you withdraw that comes from your earnings will incur taxes if you're younger than 59 ½. And the account must be at least five years old for you to use the earnings for college without a penalty. Using the earnings before that time will incur a 10% penalty. If you limit your distributions to the amount you contributed to the Roth IRA (and don't touch the earnings), and use the money for college, you won't have to pay taxes on the distribution.
• Tax Benefits: Saving in (contributing to) a Roth IRA does not provide any tax benefits in the year you save.
• Contributions: Roth IRAs are funded with after-tax dollars.
• Investing: Generally, Roth IRAs have more investment options than 529 accounts.
• Annual and Maximum Limits: Only individuals under a certain Modified Adjusted Gross Income (MAGI) threshold can contribute toward a Roth IRA. For 2024, your MAGI must be under $153,000 for single filers and $240,000 for married filing jointly couples. The annual contribution limit, as of 2024, is $7,000 for anyone under 50 and $8,000 for anyone 50 years of age and older. There is no total maximum contribution.
• Financial aid impact: The value of a Roth IRA is not counted on the FAFSA^® (though may be considered by some colleges that collect the CSS Profile^® financial aid application). However, distributions from a Roth IRA count as income on the FAFSA, which means colleges treat the amount just as they would treat earned income, which can significantly impact financial aid eligibility depending on the amount of the distribution.

In general, financial advisors recommend using a 529 account to save and pay for college expenses, as that's the original design of the account. And using a retirement vehicle, such as a Roth IRA, to pay for college means you're using your retirement money for costs other than retirement. You can't borrow money for retirement when you reach those years if you don't have enough funds, so it's important to proceed with caution when taking distributions early from any retirement account. Contact a tax advisor for more guidance on your individual financial situation.

Would you like to talk to someone about saving for college? Our college planning team is available every day, 9:00 a.m. until 5:00 p.m. at collegeplanning@mefa.org and (800) 449-MEFA (6332). Contact us. We would be happy to assist you.

Learn more about saving for college