Posted by David Macgregor

Traditional and Roth IRAs for College Savings Accounts

Traditional and Roth IRAs for College Savings Accounts

Much has been circulated to use an IRA, particularly a Roth IRA, as another type of college savings account. The basis of this idea is that you can avoid the 10% penalty for early withdrawal from the IRA if you use eligible college tuition funds.

Using a traditional Roth or IRA is an advanced financial planning strategy that requires many questionable hypotheses and is usually not recommended. The advantages of this technique are relative to the benefits of using a savings account in Section 529 or ESA coverage.

There are two smart ways to save money for college: 529 Plans and Roth IRA plans. Although 529 plans are designed to pay for education, you can still take advantage of the Roth IRA for college, even if it is meant for retirement.

Key Points

    •    529 savings plans and Roth IRA accounts are options with tax advantages for college savings.

    •    From 2019 and in 2020, you can contribute up to $ 6,000 per year ($ 7,000 if you are 50 or older) to a Roth IRA.

    •    For 529 plans, the IRS does not impose a technical limit as long as specific requirements are met.

    •    Some families use both options to save on college.

What is a 529 Plan?

A 529 plan looks a lot like a Roth IRA, but it was designed for education costs, not for retirement. Initially, one could only use a 529 to cover only the costs of post-secondary education. But it has been expanded to include up to $ 10,000 per beneficiary of k-12, per TCJA.

The types of 529 plans:

    •    Prepaid Tuition Plans: allow you to pay the beneficiary's expenses in advance in the designated schools.

    •    Savings Plans: these are savings accounts with tax advantages, similar to IRA accounts.

All 529 plans are defined at the state level, but you do not have to reside in a specific state to register for the plan. For example, if you live in New York, it is okay if you go ahead and apply for the Illinois plan.

If the initial beneficiary does not use the funds for education, you can change beneficiaries within a list of family members, including you. 

Before continuing, take a look at the pros and cons of 529 savings plans.


    •    Your state's 529 contributions can provide benefits in your state's income taxes.

    •    Contributions and income increase without taxes.

    •    No income or age limit.

    •    Substantial contributions are allowed, according to state regulations, including $ 75,000 at a time to advance a plan and further avoid tax on donations.

    •    The investment model easy to set up and forget.

    •    There are no fees for withdrawals used for spending with a qualified education.

    •    It is possible to change beneficiaries and use part of the money to pay college loans.


    •    You must use the funds for the intended purpose or pay a fine to recover it.

    •    Investment options are limited.

    •    Plans must be carefully checked to verify proper performance and costs.

    •    The plan is limited to one beneficiary at a time; Families with more children may need more.

The Benefits of 529 College Savings Plans

Contributions are not tax-deductible. However, if you reside in one of the more than thirty states that offer tax benefits for using that state's plan, you can get a full or partial tax or a partial deduction. Your money increases the taxes on your account. And there will be no fees when you withdraw money from the plan, as long as you use it for qualified education expenses

There is no income or age limit for 529 plans. The state sets annual contribution limits, but to avoid federal tax on donations, you won't have to give more $ 15,000 per year per beneficiary.

A notable exception: if you are lucky enough to have wealthy parents, you can advance 529 by contributing to the maximum gift tax ($ 75,000 per person per beneficiary/account) for five years, without paying taxes on gifts. 

Finally, a 529 plan is not a complicated investment product to manage. It relies heavily on a "configure and forget" model in which you select a specific range, contributes regularly, and watches how your balance increases.

Disadvantages of 529 college plans

First of all, since it is specific to educational expenses, you must either use the money for the intended purpose or pay the price. Although only part of the profits is subject to taxes and fines, an average income tax is paid and a fine of 10% for the recovery of money.

There are ways to claim a 10% exemption, but you will still have taxes in effect. At the very least, you can become a beneficiary, and you can use the funds to continue your education.

Second, the investment options are limited. Offers vary widely from state to state, and some 529 state plans work much better than others. If you are a smart investor, you may not appreciate the options offered. Make sure to compare the rates.

What is a Roth IRA?

You may be familiar with the Roth IRA as a retirement plan, but you can also use it to save money for college.

You can contribute to a Roth IRA irrespective of your age, as long as you have "working income" (taxable income), and you don't make a lot of money. Unlike traditional IRAs, there is no Minimum Distribution Requirement (RMD) with the Roth IRA during its lifetime. This means that you can keep your money in your account if it is not needed. And when you die, your heir can profit from years of growth and tax-free income.

Given the quality of the Roth IRA for retirement savings, does it make sense to use it to finance your college?


    •    Contributions and income increase without taxes. Contributions (but not winnings) can be withdrawn at any time without taxes or fines.

    •    When you get to the age of 591/2, all money can be withdrawn without taxes or fines to help with the expenses of children and grandchildren.

    •    The rest of Roth's money can stay with Roth to fund your pension.


    •    The annual contribution is low, compared to the contribution of 529.

    •    There is no income tax deduction for Roth contributions.

    •    Roth withdrawals are considered income for financial assistance purposes and may affect the amount of assistance that will be offered.

    •    Granting money to Roth reduces pension funds, and Roth savings are tax-free upon retirement, with no minimum distribution required.

The Benefits of Roth IRA For College Savings

Many advantages that make the Roth IRA account a good way to save up for retirement, also makes it an ideal way to save for college.

As with 529, there is no income tax deduction when you contribute to a Roth IRA. Instead, your contributions and income increase tax-free. And since you have already paid taxes, you can withdraw your contributions at any time, for any reason, without taxes.

Many families use money from a Roth IRA to pay at least part of their children's school fees. The real Roth IRA magic happens if you wait until late in life to have children or if you have savings for your grandchildren.

When you turn 59 (and have contributed to a Roth for at least five years), all your withdrawals, earnings, and contributions are not taxable. This means that 100% of your withdrawals can be spent on college expenses. If you are not yet 59 and a half, the withdrawal of your earnings will be subject to income tax, but not to a penalty for early withdrawal, provided that the money is used for college expenses.

Also, any amount of money you cannot spend in college can stay with Roth to fund your pension.

Disadvantages of Roth IRA accounts for college

First, the annual contribution limit is low. For 2020, you can contribute $ 6,000 or $ 7,000 if you are at least 50 years old. This means that in 18 years, you can add $ 108,000 or $ 216,000 if you and your spouse contribute to an IRA.

Generally, both should contribute fully to the funding of a child's college education only with contributions.

Second, unlike some 529 plans, there is no income tax deduction for RRA IRA accounts.

Third, the money inside a Roth is not counted for financial assistance. However, withdrawals are taken into account, and this can affect the package of financial assistance. Indeed, withdrawals are counted as income, even if the money is not taxable.

Finally, by using a retirement account to save money in college, reduce the amount you can save in retirement. If you are using a Roth to save for college education affects your retirement savings because it is comparable to annual contribution limits, it may be better to use 529.

Bottom Line

You can use both plans to save on college. It can be challenging to choose between a 529 plan and a Roth IRA. But there is nothing to say that you cannot finance as long as you are financially capable. This can be a good strategy. You can use 529 money first and then press Roth for any remaining expenses. Any money left over on Roth can stay there for retirement.

David Macgregor
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