A Roth IRA can be a great option for college planning in certain states because it has more flexibility than a 529 plan.
Roth-IRA advantages over a 529 account
- You can withdraw your principal contributions without taxes or penalties at any time. Normally, your earnings must stay until 59 and 1/2.
- However, if the money is used for qualified educational expenses for you, your spouse, your children, or your grandchildren, you can withdraw the investment earnings AND principle contributions penalty-free.
- Roth accounts have more investment options. No preset menus! You can even fund your child's college with a rental property in a Rocket Dollar Self-Directed account.
Disadvantages of a 529
- Income tax deduction benefits vary significantly from state to state. For example, Rocket Dollar's home state of Texas does not have any personal income tax... and thus Texans are not able to reduce their personal income with a 529 on their state tax returns.
- If your money is not used for education, you are subject to penalties. Your child might not go to school, might go to a less expensive school, or might not want to go to schools you selected in a prepaid tuition plan. College costs have been steadily rising but could change with future trends or government action.
- Limited investment options. 529 options are often preset by the state's plan.
What else should I keep in mind?
Roth IRAs will not decrease personal income, which could affect financial aid. For financial aid purposes, 100% of withdrawals from a Roth IRA and other retirement accounts count as income, even if the money isn't taxed as income.
Parents often balance their retirement and their child's education for financial goals. Remember that your child can probably take out loans, but you might not be able to. Make sure to not cannibalize your retirement. If you use a Roth IRA for college planning, make sure your retirement is taken care of with other accounts.
As mentioned a few times above, 529 plans can vary in quality for each state from fantastic to lackluster. Be sure to research your personal tax situation, child's financial aid profile, and consult your financial advisor before making a decision.