When 529 plans aren't the right choice

There's no single best way to save for college. The many 529 plans offer federal and sometimes state tax advantages. But they also lower a family's financial aid eligibility, have restrictions on where money can be invested and are subject to market fluctuations.

They also come with penalties when beneficiaries decide not to attend college, attend unaccredited institutions or go to schools located outside the U.S.

Here are some 529 alternatives.

Roth IRA

Offering federal (but no state) tax advantages and no penalty if the child decides not to attend college, Roth IRAs could be a better bet for low-income families who rely on financial aid.

One of the few savings vehicles that won't count against families when determining aid eligibility, Roth IRAs allow each parent under the age of 50 to invest up to $5,000 per year ($6,000 for parents over age 50) to pay for any qualified educational expense at an accredited U.S. school without penalty.

Richard Joseph, a college funding adviser and owner of MVP College Funding LLC in North Andover, Mass., says Roth IRAs come with drawbacks beyond the yearly contribution cap.

"You can't use any Roth IRA earnings for education," he says. "Your college savings money won't grow in a Roth."

Darren Scrimpshire, a licensed financial adviser with Sapient Financial Group in San Antonio, says that Roth IRA funds aren't calculated as an asset when financial aid is doled out but will count against families once they've started making withdrawals.

"Once funds are taken out of a Roth, you have to pay taxes on them, which could affect your (aid) for next year," he says. "If you made $50,000 this year and withdraw $10,000, it looks like you made $60,000."

To get the maximum financial aid, Joseph and Scrimpshire recommend taking out a loan for the first few years of college, deducting the interest on your taxes and using Roth IRA funds for the last year or two.

Education tax credits

Families that only save in a 529 plan can't use those funds to obtain education tax credits, too. For low savers and those who have waited until the last minute to start saving, the credit can be more valuable than throwing small amounts into a 529 plan.

The IRS reports that families can currently cash in on two tax credits. For single filers with incomes less than $80,000 per year ($160,000 for joint filers), the American Opportunity Credit grants families credits of 100 percent of the first $2,000 spent on tuition, fees and course materials, and 25 percent of the next $2,000 per student for up to four years. For families that only have a few thousand saved for college and have waited until their child is in high school to invest it, the returns on a 529 aren't likely to reach the same level of savings.

Ryan Himmel, a CPA and founder of, a website that connects consumers with financial experts, says that a 529 plan makes sense in states that offer a match for low-income households. Otherwise, "(families should) first apply the education credit to (college) expenses and then apply funds from a 529 plan for remaining costs," he says.


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