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Higher education costs have rocketed for decades … and parents are getting knots in their stomach trying to figure out how they’re going to save enough money to send their kids to college. 529 plans are the most popular vehicle when it comes to saving for education costs, but there are viable alternatives to 529 plans—such as Roth IRAs.

So, which is better when it comes to saving for college: a Roth IRA or a 529 plan? Both offer tax advantages, and your money can be invested and grow using either option. But there are several important differences between the two accounts that parents need to consider. Plus, a new rule taking effect in 2024 could tilt the scales for some families.

Obviously, if you’re trying to decide between a Roth IRA or 529 plan, you need a clear understanding of how the two options can help you save for your child’s education. To that end, let’s dive into how Roth IRAs and 529 plans work, their benefits and limitations, financial aid considerations, and more. 

With this information in hand, it will be easier to determine which option, or a combination of the two, is the best fit for your family’s education savings.

Related: 11 Education Tax Credits and Deductions

What Is a Roth IRA and How Does It Work?


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Let’s start with some general information about Roth IRAs, which you can usually open for free with any major brokerage firm.

While Roth IRAs are designed for retirement savings, you can also use them to save for other things—like higher education expenses. However, before you consider using a Roth IRA to save for college, it helps to know the basics of how a Roth IRA works.

Income Tax Treatment of Roth IRAs

A Roth IRA is a tax-advantaged retirement savings account. The main tax benefit is that money in the account grows tax-free and isn’t taxed when you withdraw it in retirement if certain conditions are met.

Account owners contribute “after-tax” money to a Roth IRA (only cash contributions are allowed). In other words, you don’t get a federal tax deduction when you put money in a Roth IRA (as you do when you contribute to a traditional IRA). So, in essence, you pay income tax on the money before you put it in the account.

WealthUp Tip: Low- and moderate-income people might also qualify for the Saver’s Credit if they contribute to a Roth IRA. This tax credit can be worth up to $1,000 ($2,000 for married couples filing a joint return).

However, you can withdraw contributions to a Roth IRA at any time without paying taxes again or facing a penalty. Earnings in the account can be withdrawn tax- and penalty-free once you’re 59½ years old as long as you’ve had a Roth IRA for at least five years.

If you take money out of a Roth IRA before turning 59½, you’ll usually owe income taxes on the withdrawn earnings and could also be hit with a 10% penalty (there are exceptions to the rule).

Related: How to Pay for College [12 Ways to Save for Tuition + More]

Roth IRA Contribution Limits

One negative aspect of Roth IRAs is that there are limits on how much money you can put in them each year.

First, contributions for the year can’t exceed the account holder’s “earned income” for the year. According to the IRS, earned income includes “wages, salaries, tips, professional fees, bonuses, and other amounts received for providing personal services.”

Self-employment income also counts as earned income. However, if you’re self-employed, don’t include any contributions made to retirement plans on your behalf or the deductible part of your self-employment taxes.

What’s not treated as earned income? Among other things:

  • Interest, dividends, rental income, and other earnings and profits from property
  • Pension or annuity income
  • Deferred compensation from a previous year
  • Amounts excluded from gross income for tax purposes

Second, there’s an income limit on contributions that’s based on the filing status used on your tax return for the year (the limit is adjusted annually for inflation). For 2023, you can’t contribute anything to a Roth IRA if your modified adjusted gross income (AGI) for the tax year is:

  • $228,000 or more if your filing status is married filing jointly or surviving spouse ($240,000 or more for 2024)
  • $153,000 or more if your filing status is single, head of household, or married filing separately and you didn’t live with your spouse at any time during the year ($161,000 or more for 2024)
  • $10,000 or more if your filing status is married filing separately and you lived with your spouse at any time during the year (no change for 2024)

Third, there’s an annual IRA contribution limit based on your age (the limit is adjusted annually for inflation). For 2023, the most you can put in a Roth IRA is $6,500 if you’re under 50 years old at the end of the year ($7,000 for 2024). If you’re 50 or older by Dec. 31, 2023, you can put in up to $7,500 for the year ($8,000 for 2024).

WealthUp Tip: An annual contribution limit applies to the combined total of contributions to all your IRAs—both traditional and Roth IRAs. For example, if you put $2,000 in a traditional IRA in 2023, the most you can put in a Roth IRA for the tax year is $4,500.

The maximum annual contribution is gradually reduced to zero if your income is within a certain range. For 2023, your annual contribution limit is phased-out if your modified AGI for the tax year is:

  • $218,000 to $228,000 if your filing status is married filing jointly or surviving spouse ($230,000 to $240,000 for 2024)
  • $138,000 to $153,000 if your filing status is single, head of household, or married filing separately and you didn’t live with your spouse at any time during the year ($146,000 to $161,000 for 2024)
  • $0 to $10,000 or more if your filing status is married filing separately and you lived with your spouse at any time during the year (no change for 2024)

Related: Best Investments for Roth IRA Accounts

Roth IRA Investment Options

When you open a Roth IRA with most banks or brokerage firms, there’s typically a wide variety of investment options. For example, you can often invest in stocks, bonds, mutual funds, exchange-traded funds (ETFs), money market funds, CDs, and/or annuities.

However, if you’re looking for additional investment opportunities (e.g., investments in real estate or cryptocurrency), you’ll probably need to open a self-directed IRA (SDIRA). With a SDIRA, you directly manage the account. Not all SDIRA custodians allow the same investments, though. So make sure to sign up for one that offers the alternative investment(s) you want the most.

No matter what, you can’t invest in life insurance through an IRA.

Also be careful with investments in collectibles. If your Roth IRA invests in collectibles, the amount invested is treated as a distribution from the account, which might result in a 10% penalty if it’s considered an early distribution. Among other things, the IRS considers the following items to be “collectibles” for IRA investing purposes:

  • Artwork
  • Rugs
  • Antiques
  • Metals
  • Gems
  • Stamps
  • Coins
  • Alcoholic beverages (e.g., investing in wine)

You can use an IRA to invest in certain gold, silver, or platinum coins. You can also invest in certain gold, silver, palladium, and platinum bullion.

Related: How Much to Save for Your Kid’s College

Use of Roth IRA Funds to Pay for College

Even though they’re meant to be used to save for retirement, you can still use funds in a Roth IRA to pay college costs for yourself, your spouse, your child or grandchild, or your spouse’s child or grandchild. While an account is typically in a parent’s name, you can also open a Roth IRA for your child (as long as the child has earned income).

First, Roth IRA contributions can be withdrawn at any time and used for any purpose. If you’re at least 59½ years old, earnings can be pulled from a Roth IRA and used to pay for college, too. In both cases, there’s no income tax or penalty on the withdrawn funds.

If you aren’t 59½ years old yet, you will owe income taxes on money taken out of a Roth IRA and used for educational expenses. However, you won’t owe the 10% early withdrawal penalty, since there’s an exception for funds used to pay “qualified higher education expenses.”

Eligible costs are generally those required for the enrollment or attendance at an eligible educational institution, including:

  • Tuition, fees, books, supplies, and equipment required for the enrollment or attendance at an eligible school
  • Room and board for students who are at least half-time
  • Special needs services incurred in connection with enrollment or attendance at an eligible school
  • Computers or peripheral equipment, software, and internet access used primarily by a student while enrolled at an eligible school (not including software designed for sports, games, or hobbies unless it’s predominantly educational in nature)

An eligible educational institution includes any college, university, vocational school, or other post-secondary educational institution eligible to participate in federal student aid programs.

How Does a Roth IRA Affect Financial Aid?

Money in a Roth IRA is ignored on the Free Application for Federal Student Aid (FAFSA) form for both the student and the parents. However, withdrawn money counts as income and can negatively affect financial aid eligibility.

Related: Best Investments for Grandchildren: Ways to Save & Invest

When Should You Use a Roth IRA to Pay for College?


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The Roth IRA contribution limits can significantly hamper a family’s ability to save enough money for college. However, there are still some scenarios under which a Roth IRA can be an excellent vehicle for education savings.

You’re Not Sure If Your Child Will Need Money for College

Not sure your child will even attend college? Does a scholarship or generous financial aid package seem likely? No problem if you’re saving for college costs with a Roth IRA.

If you end up not needing the money you put into a Roth IRA for a child’s college education, the funds can continue to grow and be withdrawn tax-free during retirement.

You can never have too much money saved for retirement. Plus, with a Roth IRA, there are no required minimum distributions, so you can keep the money in your account for as long as you want.

You’re Getting a Late Start on Saving for College

If you’ve waited a bit later in life to have children or to start saving for their education, but you opened a Roth IRA early in life, you might have accumulated a substantial amount of money in your Roth IRA by the time your children are ready for college.

In this case, you might have a tough time to save enough for a college education using a 529 plan. If the money is already in your Roth IRA, it might make sense to pull funds from that account to pay for college expenses. This is especially true if you’re already at least 59½ years old and don’t have to pay income taxes on withdrawals from the account.

But please be very careful with this approach! You will still need money for your own retirement. Don’t dip into your retirement savings to pay for college if you don’t have other sources of income that can cover your own retirement expenses.

You Want More Investment Options

You’ll have plenty of investment options with a Roth IRA—especially when compared to a 529 plan, which often offers more limited options.

Plus, if you really want to expand your investment options, you can open a SDIRA. However, there are potential traps with SDIRAs, so consulting with a certified financial planner or tax professional before setting up a SDIRA is recommended.

You Want to Maximize Financial Aid Eligibility

Since retirement savings accounts aren’t reportable assets on the FAFSA form, using a Roth IRA to save for college could improve your child’s chances of receiving or boosting financial aid.

However, the financial aid impact might not be worth it. For example, if the contribution or income limits make it too difficult to save for college with a Roth IRA, or there are clear advantages to using a 529 plan to save for your child’s education, the potential financial aid bump might be too small to trump those other factors.

Related: Child Tax Credit FAQs [What Every Parent Needs to Know]

Fidelity Investments Roth IRA


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Fidelity
  • Account minimum: None
  • Minimum initial deposit: None
  • Fees: Fidelity Roth IRA: No annual, opening, or closing fees; Fidelity Go Roth IRA: 0.35% annual fee

Fidelity offers two Roth IRA options: the Fidelity Roth IRA and Fidelity Go Roth IRA.

The Fidelity Roth IRA likely makes more sense for self-directed investors. It lets you pick and choose your investments, and you won’t be subject to advisory fees. Further, a Fidelity Roth IRA isn’t subject to account minimums, has extremely minimal fees, and offers commission-free trades. While you can expect no opening fees, closing fees, or annual fees with a Fidelity Roth IRA, you might pay mutual fund fees and fees for other managed accounts—however, these are fairly standard costs no matter which provider you choose.

Assets offered include individual securities, such as stocks, bonds, certificates of deposit (CDs), annuities, exchange-traded funds (ETFs), or mutual funds, which include the Fidelity Freedom target-date retirement funds series. Options trades are also available in a Fidelity Roth IRA, but the strategies accessible in the account are generally limited to options Tier 1 with the addition of spreads (up to four legs). This is very common for IRAs.

Those who prefer to be less hands-on with their investments will likely appreciate the Fidelity Go Roth IRA. With this digital account, Fidelity selects investments based on your risk tolerance and goals.

Because this is a managed account, you’ll pay annual advisory fees of 0.35% of assets under management once your balance exceeds $25,000. This figure compares favorably to competitors like Betterment that charge more for similar services. In exchange for those fees, you’ll get unlimited one-on-one coaching calls with a dedicated team of Fidelity advisors.

Also helping you save: The Fidelity Go Roth IRA account only invests in the Fidelity Flex series of mutual funds, which charge no management fees and (with few exceptions) fund expenses.

Depending on your personal needs, either account offers a compelling set of features and costs. Fidelity’s Roth IRA lineup is an inexpensive, highly functional, and flexible retirement account, and thus a Roth IRA account worth considering. Open your account today.

Related: How to Get Free Money Now

What Is a 529 Plan and How Does It Work?


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Now let’s turn our attention to 529 plans, which are designed specifically to save for a designated beneficiary’s education. You can’t have more than one beneficiary per 529 plan account, so parents with multiple children might need to open more than one account.

There are actually two types of 529 plans: investment plans and prepaid tuition plans. With an investment plan, cash contributions into your account are invested and grow tax-free as long as you use the money for eligible education expenses. With a prepaid tuition plan, you pay tuition and fees at the current rate for college expenses to be incurred years in the future.

Since investment plans are by far the most popular type of 529 plan, our discussion will focus on them.

Income Tax Treatment of 529 Plans

Like a Roth IRA, a 529 plan is a tax-advantaged investment account.

Contributions to a 529 plan are made on an “after-tax” basis—so there are no federal tax breaks when you put money in a 529 plan. (We’ll discuss potential state tax breaks in a minute.) However, earnings grow tax-free, and there are no income taxes on distributions as long as money in the account is used for qualified education expenses.

WealthUp Tip: While there’s no specific dollar-amount limit on annual contributions to a 529 plan under federal law, state 529 plans tend to establish their own aggregate contribution limits based on expected higher education costs in the state.

If 529 plan funds aren’t used for qualified education expenses, a 10% penalty applies and related earnings are considered taxable income subject to the same federal tax rates as wages, tips, taxable Social Security benefits, and other “ordinary” income.

The 10% penalty won’t be assessed if the 529 account’s beneficiary:

  • Dies
  • Becomes disabled
  • Attends a U.S. military academy
  • Earns a tax-free scholarship or fellowship grant
  • Receives veterans’ educational assistance, employer-provided educational assistance, or any other tax-free payments as educational assistance

The penalty is also waived if a 529 plan funds are included in income only because qualified education expenses were taken into account in determining the American Opportunity tax credit or Lifetime Learning credit.

State taxes

When it comes to state taxes, most jurisdictions offer a state income tax deduction or credit for contributing to a 529 plan. Only a handful of states with an income tax don’t offer any state income tax breaks for contributions to a 529 plan.

If a deduction or credit from state income taxes is available where you live, you might not get a tax break for the full amount of your contributions to a 529 plan, though. Some states limit how much qualifies for their state income tax deduction or credit.

In addition, you usually have to contribute to your state’s 529 plan to qualify for a state tax break. But there are a few states that permit a tax benefit for contributions to any 529 plan.

However, be warned that your state might not allow tax-free withdrawals from 529 plans if the funds are used for K-12 education costs.

For all the details about your state’s tax treatment of 529 plans, check with the state tax agency where you live.

Related: Best Alternatives to 529 Plans [Other College Savings Options]

529 Plan Investment Options

When you open a 529 account, you’ll likely be able to choose from a list of investment options. However, your choices are generally more limited with a 529 plan than with a Roth IRA.

Many 529 plans do offer an age-based investment option that automatically takes a more conservative approach as your child’s college enrollment gets closer, similar to target-date funds people use for retirement.

Account maintenance fees for 529 accounts also vary, so be sure to shop around.

What Are Qualified Education Expenses?

Distributions from a 529 plan are tax- and penalty-free, providing you use them on qualified education expenses. And when it comes to spending money on education, there are more ways you can use 529 plan funds than Roth IRA funds.

All the costs that trigger the Roth IRA penalty waiver are also allowed for 529 plan spending. However, you can also use money from a 529 plan to pay for certain apprenticeship program expenses, student loan repayments, and K-12 tuition.

Here’s the full list of qualified education expenses for 529 plan purposes:

  • Tuition, fees, books, supplies, and equipment required for the enrollment or attendance at an eligible postsecondary school
  • Room and board for students who are attending an eligible postsecondary school on at least a half-time basis
  • Special needs services incurred in connection with enrollment or attendance at an eligible postsecondary school
  • Computers or peripheral equipment, software, and internet access used primarily by a student while enrolled at an eligible postsecondary school (not including software designed for sports, games, or hobbies unless it’s predominantly educational in nature)
  • Fees, books, supplies, and equipment required for participation in a registered and certified apprenticeship program
  • Up to $10,000 of student loan payments owed by the 529 plan beneficiary or the beneficiary’s sibling
  • Up to $10,000 of tuition at an eligible elementary and secondary school

As with Roth IRAs, higher education expenses can be paid to any college, university, vocational school, or other post-secondary educational institution eligible to participate in federal student aid programs.

What Happens If You Have Leftover Funds in Your 529 Plan?

There are a number of options available if there’s money left in a 529 plan after the beneficiary is done with school.

One popular way to use leftover funds in a 529 plan is to transfer the funds to a family member’s 529 account. For example, the beneficiary’s younger sibling can use the funds for college, a parent can use it for work-related training at a vocational school, or a nephew can use it for private K-12 school tuition.

Surplus funds can also be transferred to a family member’s ABLE account, which is a savings account for people with disabilities. However, first make sure the transfer doesn’t exceed the ABLE account’s annual contribution limit.

Starting in 2024, a beneficiary can also transfer up to $35,000 of leftover money in a 529 plan into a Roth IRA in his or her name. Any rollover is subject to annual Roth IRA contribution limits, and the 529 account must have been open for at least 15 years.

While this change puts a significant dent in one of the reasons why you might want to use a Roth IRA to save for college (i.e., having retirement savings if you end up not having to pay for college), the $35,000 cap on transfers doesn’t completely negate the usefulness of Roth IRAs for people who aren’t sure if their children will attend college.

Up to $10,000 can also be used to pay off student loans for the beneficiary or a sibling.

Another option is to leave the money in the account. The beneficiary might eventually decide to take additional courses, attend graduate school, or even pass the leftover funds on to children of their own.

Finally, if necessary, the account can be drained and used for non-qualified expenses. Of course, account earnings will be considered taxable income and a 10% penalty must be paid (unless an exception applies). However, at that point the account can be closed and the account holder can move on. This option should be considered the last resort.

How Does a 529 Plan Affect Financial Aid?

A 529 plan can affect your child’s financial aid, but the impact is typically minimal. The effect is also more complicated with a 529 plan than with a Roth IRA.

A student’s financial aid eligibility is generally based on his or her expected family contribution (EFC). A higher EFC typically means less in financial aid. Students are expected to use a higher percentage of their assets to pay for college (20%) than what their parents are expected to pay (up to 5.64%). So, it’s better to have income and assets assigned to the parents rather than to the student.

If held by either the student or the student’s parents, 529 accounts are treated as parental assets on the FAFSA form. That’s a good thing. Plus, withdrawals from the student- or parent-held accounts don’t impact financial aid at all if the funds are used for qualified education expenses.

If a 529 account is opened by someone other than the student or the student’s parents (e.g., a grandparent or other relative), the account isn’t reported on the FAFSA form. However, withdrawals from the account will be treated as untaxed income for the student, which has a negative impact for financial aid purposes. For this reason, it’s often better for a 529 account to be in a parent’s name.

Related: Best Ways to Save Money for Kids

529s with Backer


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Backer
  • Available: Sign up here
  • Price: Flat fee of $1.99 per contribution

A great 529 plan option to consider is Backer. Backer—a hassle-free 529 savings plan where your family and friends can play a role—has helped families save more than $30 million toward college in just minutes.

You can use the 529 plan to put your child on track to afford college; all while remaining invested in an asset class that will grow over time. Backer allows you to invest in a portfolio of low-cost index funds that track major indexes of large company stocks (S&P 500), small-cap stocks (Russell 2000) international company shares (MSCI EAFE Index), and U.S. government bonds (Barclays Aggregate Bond Index).

Interested in learning more or signing up? Visit Backer today.

Related: Best Apps That Give You Money for Signing Up

When Should You Use a 529 Plan to Pay for College?


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As you can see, there’s good reason why 529 plans are so popular. And they’re only getting better with the addition of rollovers of excess 529 plan funds to a Roth IRA starting in 2024.

If you’re deciding between a Roth IRA and 529 plan to save for college, here are a few scenarios under which a 529 college savings plan is probably the better choice.

State Tax Breaks Are Available

If your state offers an income tax deduction or credit for contributions to a 529 plan, that very well may be enough on its own to get you to open a 529 account. Depending on where you live and how much you put into a 529 plan, you can save hundreds—or even thousands—of dollars over the years from these state tax breaks. For many people, that’s too much money to leave on the table.

You Earn Too Much to Contribute to a Roth IRA

Contributing to a Roth IRA isn’t an option for everyone. As noted above, your modified AGI must be less than $153,000 if you’re single ($228,000 for married couples filing jointly) to even contribute to a Roth IRA for the 2023 tax year ($161,000 and $240,000, respectively, for 2024). Plus, if your income is close to the limit, your maximum annual contribution limit might be lower.

So, for some people, the Roth IRA vs. 529 plan debate is irrelevant because you can’t even put money in a Roth IRA if your income is too high.

You Need to Catch Up on College Savings

Suppose your child is only a few years from college, and you haven’t started saving yet. Roth IRAs have strict yearly contribution limits, so playing catch-up is difficult with a Roth IRA.

On the other hand, there aren’t any federal annual contribution limits for 529 plans (although states can impose limits for purposes of their own tax breaks). But contributions to a 529 plan are considered “gifts” for federal gift tax purposes. As a result, if your contributions to anyone’s 529 plan during the year exceed the annual gift tax exclusion amount ($17,000 for 2023; $18,000 for 2024), you must report the gifts to the IRS and possibly pay tax on them.

There’s a work-around for the gift tax limitation, though. You can contribute five years’ worth of gifts to a beneficiary’s 529 plan in one year (i.e., up to $85,000 for 2023 or $90,000 for 2024) without having to pay gift tax. However, you still have to report the gift to the IRS.

While this certainly isn’t a pathway many have available, if it is, this is an excellent way to quickly fund college savings in a tax-advantaged way. Just be careful, because giving other gifts to the beneficiary during the year can complicate this strategy.

You’re Certain Your Child Will Go to College and Need Money

One advantage of using a Roth IRA to save for college is that your money can still grow tax-free in the account and be used for retirement if your child doesn’t attend college. Meanwhile, if you pull out earnings from a 529 plan to pay unqualified expenses, that money is subject to income tax and a 10% penalty.

That advantage will be diminished starting in 2024, when you can start transferring up to $35,000 of unused funds from a 529 plan to a Roth IRA. Plus, as noted earlier, there are other options if you have leftover money in a 529 plan. So, you don’t necessarily have to pay tax and a penalty on excess 529 funds.

Nevertheless, if you have full confidence your kid will attend college, transfers and rollovers won’t be necessary. In that case, since funds will actually be used for educational expenses, a 529 plan is likely a better college savings option than a Roth IRA for most people given the broader tax advantages and higher annual contribution potential.

Related:

Rocky has been covering federal and state tax developments for over 25 years. During that time, he has provided tax information and guidance to millions of tax professionals and ordinary Americans. As Senior Tax Editor for WealthUp from Jan. 2023 to Feb. 2024, Rocky spent most of his time writing and editing online tax content.

Before working for WealthUp, Rocky was a Senior Tax Editor for Kiplinger, where he wrote and edited tax content for Kiplinger.com, Kiplinger’s Retirement Report and The Kiplinger Tax Letter. Prior to his time at Kiplinger, Rocky was a Senior Writer/Analyst for Wolters Kluwer Tax & Accounting. In that role, he managed a portfolio of print and digital state income tax research products, led the development of various new print and online products, authored white papers and other special publications, coordinated with authors of a state tax treatise, and acted as media contact for the state income tax group (where he was quoted as an expert by USA Today, Forbes, U.S. News & World Report, Reuters, Accounting Today, and other national media outlets). Before that, Rocky was an Executive Editor at Kleinrock Publishing, which provided tax research products for tax professionals. At Kleinrock, he directed the development, maintenance, and enhancement of all state tax and payroll law publications, including electronic research products, monthly newsletters, and handbooks.

Rocky has a law degree from the University of Connecticut and a B.A. in History from Salisbury University.