Saving Student Debt

3 Ways to Save for College — Which is Right for You?

Pros:

  • No taxes on your earnings
  • Most costs are eligible, including K-12 education expenses
  • Like the 529, you can change beneficiaries to include siblings, grandchildren and other family members
  • A wide range of investment options
  • The freedom to change your investments regularly

Cons:

  • Low contribution limits capped at $2,000 per year
  • Income limits reduce the amount you can invest if you make more than $95,000 per year
  • Not FDIC-insured, so you could lose money
  • You must spend the money by the time the beneficiary turns 30 or pay a 10 percent penalty on the amount that’s left

Roth IRA

Though technically a retirement plan, the Roth IRA allows investors to make withdrawals for college expenses without paying the penalty that’s normally charged when you take out retirement money early. Unlike a traditional IRA, the money you put into a Roth happens after taxes, so you won’t be taxed on the principal or earnings ever again.

While it’s generally risky to dip into your retirement fund early, the flexibility of a Roth makes it a good choice for some investors.

Pros:

  • You can withdraw your principal — the amount you contributed — at any time, with no penalty, to use for anything you want
  • You can withdraw earnings without the 10% penalty that normally comes with early retirement account withdrawals if you use the money for higher education expenses
  • You have total control over your investment strategy and can shop around for low fees, etc.
  • The money stays in your name rather than having to name a beneficiary

Cons:

  • Annual contribution limits of $5,500 per year if you’re under age 50; $6,500 per year if you’re over age 50
  • If you take money out for higher education expenses before age 59 1/2, you’ll have to pay capital gains taxes on the earnings (though not the principal)
  • Pulling money from your retirement account can leave you short on funds later in life if you don’t have other sources of retirement savings, such as a 401(k) or pension
  • Withdrawals from your Roth count as income for FAFSA calculations, which could reduce your child’s need-based financial aid package

So which plan is right for you? It depends on what you value most. If you’re a savvy investor who wants control over how you allocate your funds, a Coverdell or Roth will be more appealing. If you already have your retirement in order thanks to a strong 401(k) with matching funds from your employer, a Roth won’t be a big gamble for you since you can afford to make some withdrawals without putting your retirement plans on hold.

For most American families, though, the 529 plan offers the best combination of tax breaks without forcing you to spend the money on college for a certain beneficiary if they end up having other plans. Because it comes with a high contribution limit and the ability to name many other beneficiaries, it’s a good way to take advantage of the tax savings while putting money aside for college.

No matter which plan you choose the most important thing is to open one and make start making a monthly contribution — no matter how small — right now.

About the author

Beth Trach

Beth Trach

Elizabeth Trach is a writer and editor living in Newburyport, MA. She also sings in a band, grows almost all her own food, and occasionally even cooks it. You can catch up on all her adventures in frugal living and extreme gardening at Port Potager.

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