College savings: 529 plan or Roth?
Dear Dr. Don,
I am looking to open a savings account for my 3-year-old daughter’s college funding. What are the advantages/disadvantages of a Section 529 plan versus a Roth IRA? Thanks in advance.
— Sergio Savings
Great question. There’s not going to be one right answer for everyone, so I’ll work on finding the answer that’s right for you. After all, that’s why they call it “personal” finance.
First off, there’s a difference between a Section 529 college savings plan and a Section 529 prepaid tuition plan. Prepaid tuition plans capture college cost inflation. By doing so, they provide a better hedge when investing over the long term.
That said, a prepaid tuition plan isn’t right for everyone. Because the provisions vary by state plan, you’ll want to do some research on them. Bankrate’s Savingforcollege.com provides a nice primer on its “What is a 529 plan?” Web page.
When shopping for a plan, pay close attention to the tax breaks offered by your state on plan contributions. Some states limit these tax breaks to only the contributions made to plans in your state of residence.
A Roth IRA does have provisions that allow distributions out of the account for qualified higher education expenses. I like the flexibility of the Roth IRA in allowing you to keep the money working toward your retirement.
If you’re pretty comfortable with your retirement savings plan and can comfortably dedicate a portion of your income to dedicated college savings, choose the dedicated college savings options available in a Section 529 plan.
The Section 529 can give you state tax breaks on your contributions that a Roth IRA does not. A prepaid tuition plan should provide a better hedge against college cost inflation than a savings plan or a Roth IRA.
If you’re less certain of being able to keep the money dedicated to college savings, then the flexibility of a Roth IRA allows you to maintain a measure of financial flexibility in your finances.
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