529 or an IRA for College Savings

Posted by 1 September, 2008

Photo by bdjsb7
529’s are a new area for me. I’m looking into starting a 529 for my neice to get her jump started. When looking at various 529 plans, I thought to myself, why not just use a Roth IRA? I thought it was a clever idea because I knew that within a Roth IRA, one could withdraw money for education expenses. I thought that if the child did not go to college, investing in a Roth IRA instead of a 529 plan, the child would be able to use the money in a Roth IRA account towards retirement savings. Before jumping at this, I wanted to do a little homework to investigate whether my idea or the idea I had heard was legal and whether it was the best plan of action.
I found an article by Joseph Hurley at Bank Rate who is known as the “College Savings Guru”.

1. He states that the contributor of an IRA must make the amount of money equal to the contribution amount. In other words, the person has to have an income and unfortunately my 4 month old neice does not have any income (although she is very cute and would look good in an ad).

2. The Roth IRA account distribution is considered as income for the student for that year. That could be a real problem when being considered for financial aid.

3. The 529 plan really pulls ahead in regards to the earnings that have accumulated from the contributions. In a 529, these earnings are tax free if they are used for educational expenses. In the case of a Roth IRA, the earnings are not tax free when you receive the distribution. However, if the earnings are used for educational expenses, you avoid paying a 10% penalty.

4. One positive aspect of using a Roth IRA is that you can use your contributions on anything including education, tax free as long as you have had the money in the IRA for more than 5 years.
It looks like the resounding answer to my question of whether a Roth IRA a better tool for college savings than a 529 plan, is NO. Looks like I need to now look into various 529 plans and see which plan might be best.

Before looking at various 529 plans, I need to set up criteria for my search. In my opinion, besides the plan being open to out of state residents, the number one factor to look at is costs. If the plan is going to eat at my returns with fees for management and mutual fund fees, it defeats the purpose of using a tax-free vehicle.
Here is the website I’m going to use to compare various 529 plans:
Here are some additional articles about 529 plans from across the web:
529 Plans: Helping To Ease The Burden of College Expenses
529 Plans: Fees More Important Than Deductions
The 5 Best College-savings Plans
Alternative to 529 plans (or how to save for college without tying up your money for 18 years)
Are These Myths Preventing You from Saving for Children’s Higher Education?
I will let you know what I decide in a future post.
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Comments
September 1, 2008

I wouldnt trust the IRA with my money:P

Posted by Sandy
September 5, 2008

Very thoughtful of you to give your niece such a meaningful gift. One way to open a 529 for her is with a Freshman Fund gift certificate. Send our gift certificate to her parents and they can redeem it into the college fund of their choice. In this case, the college fund is opened in the parent’s name with the child as the beneficiary.

Freshman Fund is a college savings gift registry that lets friends and family gift directly into a child’s college fund.

Posted by Jonah Keegan
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