While it is commonly said that for most people, a home purchase is the largest investment they will ever make, a parent’s investment in their child and the child’s future – including college tuition – oftentimes far exceeds the costs and financial complexity of a simple real estate purchase. Of all of the expenses parents face during a child’s upbringing, very few are more dreaded than the eventual price tag associated with attending college.
By taking a look at different investment options and financial planning strategies, parents can compare the different options at their disposal,which can make saving for a child’s education feasible. In this situation, most parents consider either a 529 Plan or a Roth IRA as the ideal way to save. This article will focus on a few of the advantages of each so that you can make an informed decision about the correct savings strategy for your family.
How Can a 529 Plan Help You?
A 529 plan is an investment option sponsored by either a state-level government or an educational institution. There are two types of 529 plans: prepaid tuition plans and college savings plans. Each has varying specifications to further help you create the ideal savings plan for your child. Overall, 529 plans have a number of benefits which separate them from Roth IRAs:
Of the two different types of 529 plans, prepaid tuition plans have more restrictions but allow parents to lock in tuition costs at a specific rate when opening the account. This is a great option when significant tuition increases are expected between when you open your child's savings plan and when your child attends college.
Many states offer tax deductions on contributions to eligible state-sponsored 529 plans.
There are no income restrictions on contributing to a 529 plan, so this option is open to families whose annual earnings exceed the $176,000 maximum for Roth IRAs.
Annual contribution limits are often quite high, well into six figures, whereas a Roth IRA currently has an annual cap of $5,500.
When a Roth IRA Becomes Useful
For children who earn scholarships to college, a 529 plan can be used for other educational expenditures with no penalty.
Despite the numerous advantages of investing in a 529 plan, there are still situations where a Roth IRA may be a better choice for your child’s educational planning. Here's a list of the advantages:
In the event that your child does not go to college, your invested funds can be shifted towards your retirement, rather than needing to be used for another family member’s education or facing the withdrawal fees of a 529 plan.
Roth IRAs give you much more freedom and flexibility on how to invest your funds, whereas 529 plans often have limited options.
After the age of 59, your savings can be used tax-free for any purpose, not just educational expenses.
When it comes to saving for your child’s college education, thorough planning can mean the difference between financial freedom to attend the school of their choice, and struggling to cover rising tuition costs. For parents, both 529 plans and Roth IRAs present a number of benefits and disadvantages which need to be thoroughly examined in order to choose the right investment strategy for your financial situation and child’s educational goals. Every family and student’s financial needs will be different, so it is important to carefully identify your individual savings goals before choosing any investment plans.
Editor's note: This story by Susan Lyon originally appeared on NerdWallet.
To read more from NerdWallet, see:
Americans Aren’t Saving Enough Money to Retire
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401(k) Vs. Roth IRA: Which Retirement Account Is Best for You?
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