You are well aware of the high expense of higher education; thus, it is fortunate that there are not just one but two tax-advantaged strategies to save money for college costs: roth ira vs 529 plan. Therefore, which option is preferable for you?

To begin, it is important to point out that the requirements for Roth IRAs and 529 plans are similar. (Prepaid tuition plans are not the topic of this article; rather, we will discuss 529 savings programs.) You may avoid paying taxes on the growth of your savings by contributing to a Roth IRA or 529 money after you've already paid them. As long as you don't break the rules, you won't have to pay any taxes on the money you make from investing in either of your accounts.

Even though these are retirement accounts, you can withdraw any of your contributions without penalties. This makes the Roth IRA an attractive option for many people interested in saving money because of its flexibility. Let's examine the benefits of the Roth IRA in general and the circumstances in which a 529 plan may be preferable.

Roths Are For Retirement — But They're Flexible

The creation of Roth IRAs was done to get more individuals to save money for retirement. However, in contrast to other retirement accounts, the money you have contributed to a Roth IRA may be withdrawn at any time, regardless of when it was deposited, and you won't be subject to any taxes or penalties.

Take note of how the word "contributed" is emphasized in the sentence. If you withdraw the investment gains from your Roth account before you turn 59 and a half, you will most likely be required to pay income taxes and a 10% penalty on the amount of money you remove from the account.

There are, however, a few notable exceptions: If you withdraw money from your Roth IRA to pay for eligible higher education expenses, you won't have to pay the 10% early withdrawal penalty. You will be responsible for paying taxes on any investment gains you take out of your account unless you are above 59 1/2 and have held the account for at least five years.

Mark Struthers argues that the Roth IRA is his favorite retirement account because of its adaptability and variety of investing options. I prefer to switch to the 529 plan after the Roth IRA has reached its limit. Most parents who are unclear about college expenses or how much they will pay find that the Roth IRA is the best option.

529s Are For College (And K-12, Too)

If you have a 529 plan, you won't have to pay any taxes or penalties on the money you withdraw as long as it is used to pay for approved educational expenses. As part of the "qualifying" expenditures, primary and secondary school tuition may total up to ten thousand dollars.

However, if the money is used for anything else, you may be required to pay taxes on the investment returns and a 10% penalty. If your child decides not to attend college, you won't be able to put those earnings into a retirement account as easily as you would with a Roth IRA. Nevertheless, the following are some examples of circumstances in which a 529 would be a better choice:

Consider investing in one if your state gives a tax credit for 529 plans and has a solid 529 plan. This deduction or credit is the same as getting money for nothing, and who would say no to money for nothing? (Well, you may want to if the investment alternatives offered by your state's 529 plan are subpar and have cost ratios that are higher than one percent.) We have compiled a list of the states that provide tax benefits for 529 plans.

Suppose you expect to need some financial assistance. Withdrawals from Roth IRAs are often included as income in the computation for the Free Application for Federal Student Help, also known as the FAFSA. Having more income might have a negative impact on the amount of aid that your family receives. (It is important to remember that the FAFSA does not consider the money of assets held in a Roth IRA as long as the funds remain in the account. Only the withdrawals may be painful for those receiving financial assistance.)

On the other hand, 529 plans are the opposite: Even if withdrawals from a parent-owned 529 plan won't affect financial aid, the assets in a parent-owned 529 plan will count against you on the FAFSA. However, the proportion of assistance that will be reduced due to assets is considerably lower than the percentage that would be reduced due to income. Although this is a major gain for 529 plans, Struthers adds that one option is to arrange Roth payouts for "later in college when you won't have to apply for help the next year." This is because, later in college is when you are less likely to need financial assistance.