Dear Dr. Don,
We just received a small inheritance and would like to start a college fund for our 9- and 10-year-old daughters. We live in Florida, which has no state income tax (hence, no state tax deductions). We are researching the Florida Prepaid college program, but at our daughters' current ages, the monthly payments are steep and the lump sum option is not feasible. It is my understanding that a Roth IRA could provide the flexibility and the current federal tax deduction for contributions, where the Section 529 plan does not. What is our best option?
-- Ray Roth
A Roth IRA is funded with after-tax dollars, just like the Section 529 plan, so there's not an advantage for contributions. The flexibility that the Roth IRA provides is that the money can be used for your retirement if one or both of the girls decides not to go to college or earn scholarship funds that reduce the tuition expense.
Prepaid college plans can trump college savings plans, or Roth IRAs, because they offer protection against college cost inflation. There are limitations with the prepaid plans, primarily dealing with what happens if the child doesn't go to an eligible school. The Florida Prepaid College Plans' Enrollment FAQ page spells out what happens in that situation:
The beneficiary may use their Florida Prepaid College Plan benefits at any private or out-of-state college or technical school that is an eligible educational institution by simply completing a transfer form. The Board will transfer an amount that is equal to the average rates payable to Florida state universities and colleges in Florida under your beneficiary's plan.
But the point is moot if you can't afford either the monthly payments or the lump sum option.
SavingForCollege.com, a Bankrate company, has an article, "Federal tax incentives targeted to education," that lets you compare and contrast different approaches to college savings, with an eye toward tax savings. The Roth IRA can multitask by working toward retirement and college savings goals. Since you're not getting state tax incentives for contributing toward a college savings plan and you can't afford the prepaid plan, the Roth IRA makes more sense. (There are income limitations on contributing to a Roth IRA, but they can be finessed by contributing to a traditional IRA and then converting to a Roth IRA. Talk to your tax professional if this is your situation.)
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