Roth IRAs are often mentioned an alternative to 529 savings plans as a way to save for college. Both invest after-tax savings, accumulate earnings on a tax-deferred basis and enjoy tax-free distributions if the distributions are used for qualified education expenses such as tuition, books and room and board at an eligible education institution.
But there are differences that parents and their advisors should consider when choosing one plan over the other to save for college, whose costs can run as high as $70,000 a year for a private, nonprofit institution if no financial aid is given.
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Mark Kantrowitz, publisher and vice president of research at Savingforcollege.com, compared both types of saving vehicles and found that 529 plans are a better option if parents expect their child will enroll in a higher-ed institution. The comparable benefit is even greater if the family lives in a state that offers a state income tax deduction or credit on 529 plan contributions.
Currently, 34 states plus the District of Columbia allow tax deductions or tax credits on contributions, but the benefits vary. Deductions range from roughly a couple of thousand dollars to as high as $12,000 per married couple, but some states limit them to in-state 529 plans only. Parents need to learn the details and consider whether they live in a state with an income tax.
A Roth IRA is a better choice for parents only if they have serious doubts that their child will attend college and there's no sibling or other relative who can become the new beneficiary of a 529 plan, says Kantrowitz.
The only other primary benefit of a Roth IRA over a 529 plan to finance college costs is the number of investment options. Roth IRAs usually have more options than 529 plans, but they're not necessarily needed, according to Kantrowitz.
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