Saving for college can seem like a daunting task. If you’re a parent wanting to plan ahead for your child’s education, it’s important to weigh the options and see what works best for your financial situation. One common route for college savings is a 529 plan where money can be saved and invested for future college tuition and other qualified expenses. However, there are drawbacks to the 529 plan, so it’s important to consider the other choices you have for saving for higher education.
1. Roth IRAs
You might be asking isn’t this a retirement account? Well technically Roth IRAs are for retirement, but the benefit of these accounts is they are extremely flexible and have some characteristics that are very helpful for parents who want to start saving for college.
Benefits of Roth IRAs:
- The money you put into the Roth IRA is not tax deductible the way a traditional IRA or a 401(k) account is, but it does increase in value tax free! That means you can continue to grow your account at a faster pace and not worry about added taxes along the way.
- There are no penalties or taxes to withdrawing any amount you have contributed at any time. If you contributed $5,000 to your Roth IRA, you are allowed to take that same $5,000 out whenever you want.
- The amount over what you have contributed is called your earnings. This is acquired over time with the money you have contributed. In most cases, any earnings made prior to the age of 59.5 are taxable and will have a 10% penalty. However, there is an exception to this rule. If you are withdrawing the money from your Roth IRA for qualified higher education expenses, that 10% penalty is waived. You will have to pay taxes on the earnings, but avoiding the penalties will save you money in the long run.
- Compared to a Roth IRA, a 529 plan may seem like the better option for college savings. However, flexibility is a big reason to contribute to the IRA over the 529 plan. If you want to set aside money for your child’s education, you can do so with the flexibility to withdraw money for other expenses. With the 529 plan, that money has to be withdrawn for education or you will be facing a 10% penalty. With the Roth IRA, you’re able to contribute to your child’s education, plan ahead for retirement and also handle any unexpected set-backs without being penalized. The added perk? If your plans change, you can always use the money for retirement with no risk of losing any contributions or earnings.
- Unlike a 529 plan where a percentage of the money is counted towards financial aid, a Roth IRA is ignored for the purposes of financial aid. Having a Roth IRA instead of a 529 plan will make it easier for your child to qualify for financial aid.
There are also a few drawbacks to Roth IRAs:
- While there are many purposes to these accounts, you cannot use the money for both college expenses and retirement. An easy way to avoid any confusion is to have two accounts: one for college and one for retirement, so there’s no risk of double-counting.
- Roth IRAs benefit financial aid eligibility as mentioned previously, but there’s also a drawback; if you withdraw money from the account to use for college expenses, this money will be considered income on a future FASFA application, which could result is less financial aid resources available.
- With 529 plans, you can deduct some of your contributions for state income, but with the Roth IRA, you won’t be able to receive any deductions for your contributions.
- You can always withdraw any amount you contributed without penalty, but the drawback is that you will be taxed on any amount over your contributions (your earnings).
- There are set limits on contributions to the Roth IRA. Each parent can only contribute up to $5,500 per year or $6,500 if you are over 50.
2. Life Insurance for College Savings
Another option for saving for college is to use your life insurance as an investment. Whole life insurance is typically the safest way to invest, and most policy holders can expect 3-6% return on their investment in the first few years. Policy holders can also purchase variable life insurance, where the money returned is based on how well the investments perform. There’s a greater chance of making more on your investment, but you also run the risk of losing the greatest. When your child needs the money for college, you are given money in the form of a loan. If the money is not paid back, the insurer reduces your death benefit.
Benefits? Most importantly, this plan has flexibility. Just the same as the Roth IRA, if your child decides not to go to college, you will not be hit with the heavy taxes that 529 plan owners face if they use the money for things other than education.
Another important benefit is the money isn’t included in financial aid.
The drawbacks? These accounts cost more to maintain and are more complicated than your typical 529 savings plan.
Saving for your child’s education might be an important step in planning for your future. Remember that there are options other than the traditional 529 plans out there. Just make sure you pick the best plan for your financial needs.