July 2020
College & Tax Planning

The best way to manage student loan debt is not to acquire any in the first place, of course, but not everyone has that option. The good news is that there are several different tax-advantaged savings vehicles you can use to save money to pay for your child’s or grandchild’s college education expenses, instead of taking out student loans. Two of the most common college savings vehicles are 529 Plans and Roth IRAs. 

529 Plans have become one of the most popular college savings tools in America over the past two decades. Not only do they enable you to sock away money now to help cover college expenses later, but they also offer valuable tax breaks. Investments in the account are able to grow on a tax-free basis and can be withdrawn tax-free if the funds are used to pay for qualifying education expenses. In addition, some states also allow local residents to deduct 529 plan contributions on their state income tax returns. Qualified expenses include a wide range of different costs associated with attending college. 

When most people think of Roth IRAs, they think of them as a retirement savings tool. But Roth IRAs can also be used to help pay for college expenses. Here’s why: Contributions you make to a Roth IRA can be withdrawn at any age and for any purpose without being subject to taxes and penalties. This includes paying for college education expenses. Note that this tax-favorable treatment only applies to Roth IRA principal, not earnings. One strategy employed by some families is to withdraw some of their Roth IRA principal to help pay for college expenses while leaving the earnings intact to help cover their living expenses in retirement. Using this strategy, you can use a Roth IRA to kill two birds with one stone. 

So which type of savings vehicle — a Section 529 plan or a Roth IRA — is a better option for saving money to help pay for college? The answer depends on several different factors. For example, how certain are you that your child or grandchild will attend college? Funds in a 529 plan must be used to pay for qualified college education expenses. Therefore, if you’re not fairly certain your child or grandchild will attend college, you might be better off using a Roth IRA to save for college.  

You should also consider the value of the tax benefits offered by each type of savings vehicle. The tax benefits of Roth IRAs are hard to beat: While you don’t receive a current tax deduction for contributions, funds grow tax-free and can be withdrawn tax-free to pay for college or retirement living expenses. This benefit tends to outweigh the tax-free growth offered by 529 plans over shorter periods of time. 

Keep in mind that this isn’t necessarily an either/or proposition. Many families contribute money to both a 529 plan and a Roth IRA. This strategy can provide you with the highest degree of flexibility in saving money to meet both of these critical long-term financial goals. If you have question on how to best save for your child’s or grandchild’s education, give us a call! 

If you have questions, please contact us.

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