Two popular paths are to use a 529 savings plan or a Roth IRA. There are some accounts that I tend to shy away from (UTMA, UGMA, ESA’s, & Cash Value Life Insurance) for college purposes. Depending upon the situation and risk tolerance, cash value life insurance could work if the policy was designed correctly, and you were able to start saving when the child was very young.
The 529 is very efficient when used for qualified educational expenses. In fact, I believe it is the superior option to save for college.
The downside of the 529 is when the funds do not get used for qualified educational expenses. There is a 10% penalty on the gains for a non-qualified distribution and any earnings will also be taxed as earned income for non-qualified distribution. Honestly, it is not the worst thing in the world because funds have tax-deferred growth potential, and you are not getting an annual 1099 for interest and dividends.
The Roth IRA can help you hedge against the concern of the funds not being used for qualified educational expenses. When comparing the two investment vehicles the difference in contribution limits and who can contribute must also be stated; individual limits, annual gift tax, multiple contributors, Roth earned income limits, etc. However, Roth IRA withdrawals must be held for the longer of 5 years or age 59 1/2 for the earnings to be tax-free. The Roth IRA allows for the distribution of your contributions any time penalty-free.The downside of using the Roth IRA for college is that it is depleting your future tax-free income in retirement.
Consider using the Roth IRA to compliment the 529 Plan. Also, if you have access to Super-Fund a Roth IRA (thru annual After-Tax 401k Rollovers, depending on 401(k)plan guidelines), I would prioritize that strategy over 529 Plan contributions. If you have maxed out the Super Roth strategy and you still have money to save for college, utilize the 529 Plan.
Information in this material is for general information only and not intended as investment, tax, or legal advice. Please consult the appropriate professionals for specific information regarding your individual situation prior to making any financial decision.
Prior to investing in a 529 Plan investors should consider whether the investor's or designated beneficiary's home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state's qualified tuition program. Withdrawals used for qualified expenses are federally tax-free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.
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