Sending the kids off to college is perhaps the 2nd most expensive event in a parent’s lifetime other than buying a home.  It is so expensive today with rising tuition costs & savings accounts continuing to dwindle as a result of the financial crisis.  To prepare for the high cost of college, we often hear financial planning experts instruct parents to setup a 529 Plan account.  While this can be sound advice, there are instances in which a 529 plan doesn’t make much sense at all.

A Roth IRA Can Be A Better Option
If a parent expects to be older than 59 1/2 when their child goes to college, a Roth IRA may make a lot of sense.  At this age, they can withdraw funds tax-free without any penalty AND any tax on the growth of earnings. Essentially, these are the same tax benefits of a 529 plan but with a Roth IRA account, the funds can be used for purposes other than higher education expenses.  The 529 plan does not have the same flexibility since you will be penalized if funds are used for anything other than higher education expenses. As a side note, if you are under the age of 59 1/2 you could withdraw Roth IRA funds for higher education expenses without facing a penalty, but you would be taxed on the earnings.

Family is in NEED of Significant Financial AID
529 Plan assets are actually incorporated in the financial aid calculation when colleges review a student’s FAFSA application. A Roth IRA on the other hand is excluded from the financial aid calculation because it is considered to be part of retirement assets.  Therefore, if you anticipate being in significant need of financial aid, allocating college funds to a Roth IRA makes a lot of sense.

Roth IRA Conversion Exception
The exception to the rule would be, if a parent has a traditional IRA and is considering converting to a Roth IRA because of the new favorable tax rules. A conversion would trigger a taxable event and the income from conversion would be included in the financial aid calculation.

529 Tax Deduction Not Valid in All States
Here’s a final note to keep in mind with regards to the 529 plan.  The state tax deduction is not allowed in every state so be sure to open an account in a tax-friendly state if you choose to go that route.

More Tax Questions?

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