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Saving For College: Which one is best to use, a 529 Plan or Roth IRA?

| September 13, 2018
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It’s that time of year again where bookbags, notebooks and pens line the shelves at the stores. Technology companies flood television ads with commercials for the latest laptops and notepads. Everyone is talking about who the favorite is for the NCAA National Championship this year (Let’s Go OSU!) Back to school it is.

During this Fall season, as parents start to think about their children going off to college one day, more of my client meetings center around the most effective and efficient way to save for college.  The debate always comes down to 529 Plans vs. Roth IRAs. While both options are a great savings strategy, 529 Plans offer several advantages when your child enrolls in college while a Roth IRA is better when your child decides to not go the college route.

To make things simpler for my clients and associates, I have created a list of everything that the 529 Plan & Roth IRA offers:

 

529 Plans

  • In 34 states + DC there are State Income Tax Deductions or Tax Credit on Contributions
  • The annual contribution limit is $15,000 ($30,000 as couple)
  • There is no Earned Income Cap on Contributions
  • There is a 5-year Gift Tax Averaging of $75,000 ($150,000 as couple)
  • The aggregate contribution limit is $235,000 to 520,000 (varies by state)
  • No income phase-out on contributions
  • Limited set of static and dynamic portfolios
  • Qualified Distributions: Tax-free if used to pay for qualified higher education expenses of K-12 tuition
  • Non-Qualified Distributions: Earnings portion of distribution is subject to ordinary income taxes plus a 10% tax penalty
  • The tax penalty is waived up to the amount of a scholarship or other educational assistance received by the student
  • Aid eligibility reduced by up to 5.64% of asset value if account is owned by a dependent student or the student’s custodial parent. If account is owned by anybody else, including a grandparent, aunt or uncle, it is not reported as an asset on the FAFSA
  • If the account is not reported as an asset on the FAFSA, qualified distributions count as income to the student, reducing aid by up to half of the distribution amount. Non-qualified distributions are reported in the student’s income
  • Distributions that occur on or after January 1 of the sophomore year in college will not affect aid eligibility if the student graduates in four years

 

Roth IRAs

  • There is no State Income Tax deduction or Tax Credit on contributions
  • The Annual Contribution Limit is $5,500 ($6,500 if age 50+)
  • There is an earned income cap on contributions
  • There is no 5-year gift tax averaging or aggregate contribution limit
  • The income phase-out on contributions is $189,000 to $199,000 (MFJ) $120,000 to $135,000 (S)
  • Does not allow contributions by third parties
  • Broader set of investment options, including stocks, bonds, mutual funds and ETFs
  • Tax-free if age 59-1/2 and held for five years. Tax-free return of contributions at any time
  • Earning portions of distribution is subject to ordinary income taxes plus a 10% tax penalty
  • The tax penalty is waived if the non-qualified distribution pays for educational expenses.
  • Nor reported as an asset on the FAFSA
  • All distributions, including a tax-free return of contributions, count as taxable or untaxed income on the FAFSA. This reduces eligibility for need-based financial aid by up to half of the distribution amount.
  • Distributions that occur on or after January 1 of the sophomore year in college will not affect aid eligibility if the student graduates in four years

Each plan offers it’s pros and cons but it all comes down to you and what you see working best for you and your family.

We would welcome the opportunity to take some time to sit down with you, talk through each plan and help you make an informed and accurate decision. Give us a call today!

Comparisons found on www.SavingforCollege.com

 

Lincoln Financial Advisors Corp. and its representatives do not provide legal or tax advice. This information should not be construed as legal or tax advice.  You may want to consult a legal or tax advisor regarding any legal or tax information as it relates to your personal circumstances.

CRN-2231648-090418

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