Author Topic: 529 vs Roth IRA  (Read 2830 times)

Dansandiego

  • 5 O'Clock Shadow
  • *
  • Posts: 5
529 vs Roth IRA
« on: November 19, 2016, 11:13:36 AM »
Trying to figure out which of these options would be better for my children (they are in early teenage years):
Option 1 - I match every dollar they earn with a $1 contribution to their 529.
Option 2 - I match every dollar they earn with $1 they can contribute to a Roth IRA.

Would their 529 balance or Roth IRA balance be omitted for purposes of financial aid to college?

PhoenixHeat

  • 5 O'Clock Shadow
  • *
  • Posts: 67
Re: 529 vs Roth IRA
« Reply #1 on: November 20, 2016, 08:32:24 AM »
I believe the 529s wouldn't factor into their financial aid if the account is held by someone other than the student  (you the parent).

This is one of the reasons that helped me decide to start funding 529s for my two children.

John

sol

  • Walrus Stache
  • *******
  • Posts: 8433
  • Age: 47
  • Location: Pacific Northwest
Re: 529 vs Roth IRA
« Reply #2 on: November 20, 2016, 10:20:31 AM »
I recommend the Roth, unless there are significant savings on state income tax from using the 529.

529 accounts are always assessed as parental assets, rather than student assets, so your financial aid calculations award is penalized less.  Colleges want to make the student broke first, and then parents broke second.  But it doesn't really matter if you're planning to spend the money on college anyway, because you're going to spend every dollar in that account either way.

The Roth IRA is a retirement account, and is not assessed for financial aid calculations at all.  It's an excluded asset.

Roth IRA accounts can be tapped for college expenses at any time, without paying taxes or penalties.  The problem with using them for college is that the annual contribution limits are pretty small, and they cut into your ability to save for your own retirement if you use them for college. 

If the kids have earned income, they can set up their own Roth IRA in their own name, which can also be used for college expenses at any time without paying taxes or penalties, and you can fund it up to the amount of earned income they have, or the annual limit.  But if they were to fund it with their own money, there is very little benefit in it because they typically pay no taxes anyway, and the money won't sit there long enough to grow significantly more because of its tax deferred status than it would in a regular taxable investment account.


Metric Mouse

  • Walrus Stache
  • *******
  • Posts: 5278
  • FU @ 22. F.I.R.E before 23
Re: 529 vs Roth IRA
« Reply #3 on: November 20, 2016, 11:24:17 AM »
Thank you so much Sol.  I was trying to work through this debate myself; you've laid out both sides very clearly. I truly appreciate it.

seattlecyclone

  • Walrus Stache
  • *******
  • Posts: 7254
  • Age: 39
  • Location: Seattle, WA
    • My blog
Re: 529 vs Roth IRA
« Reply #4 on: November 20, 2016, 06:27:19 PM »
529 accounts are always assessed as parental assets...

This is not always the case. Every 529 account has two relevant people: the owner and the beneficiary (student). The owner can be the parent, another relative, or even the student themselves. The most common case is for the parent to be the owner, in which case the account is assessed as a parental asset. If the owner is the student, it will be counted as a student asset. If the owner is a different relative (grandparent, aunt/uncle, etc.), it doesn't need to be reported as an asset on the FAFSA at all. This sounds like a great thing at first, but the catch is that distributions from such an account are assessed as student income. For this reason, grandparent 529 accounts are best left alone until the student is almost done with school, after they've filed their last FAFSA.

msilenus

  • Pencil Stache
  • ****
  • Posts: 524
Re: 529 vs Roth IRA
« Reply #5 on: November 20, 2016, 07:47:28 PM »
Roth IRA accounts can be tapped for college expenses at any time, without paying taxes or penalties.  The problem with using them for college is that the annual contribution limits are pretty small, and they cut into your ability to save for your own retirement if you use them for college.

Roths should tend to be worse for financial aid.  The 529 counts against assets, which is bad; but Roth withdrawals count as income, which is worse.

Quote from: http://www.savingforcollege.com/financial_aid_basics/financial_aid_and_your_savings.php
Though the tax law now permits penalty-free withdrawals from a traditional or Roth IRA to pay for qualified college costs, doing so could jeopardize financial aid in the following year. The entire withdrawal, principal and earnings, counts as income on the following year's aid application.

That's not to say that Roths are the wrong choice --I think they're still going to be preferred over 529s for most people who are choosing between them.  It's way more important to cover your retirement than your kids' college.  If you need conversions to qualify for contributions then it's less likely that Roths will be available to you in future years. (An appetite for reforming that avenue away seems to have developed on the Hill.)  There's no problem with using a Roth for the last year of college, after FAFSA has been filled out.  They perform way better if your kids don't actually go to college or if they get a scholarship.  The Roth space is more scarce than 529 space, so it's more likely that you'll be able to "catch up" later into a 529 than into a Roth.  You could even build up a 529 while retired because you don't need earned income.

Personally, I can't imagine funding a 529 in a year when my Roths aren't already capped off.  However, that's in spite of the financial aid implications.

ChiefMomOfficer

  • 5 O'Clock Shadow
  • *
  • Posts: 14
    • Chief Mom Officer
Re: 529 vs Roth IRA
« Reply #6 on: November 22, 2016, 05:29:00 AM »
Trying to figure out which of these options would be better for my children (they are in early teenage years):
Option 1 - I match every dollar they earn with a $1 contribution to their 529.
Option 2 - I match every dollar they earn with $1 they can contribute to a Roth IRA.

Would their 529 balance or Roth IRA balance be omitted for purposes of financial aid to college?

The ROTH would be omitted for financial aid purposes. The 529 would count, but as a parental asset. Someone below mentioned it would count more if it's in your kids name, which is true, but being under 18 they can't technically own either account in their names.

The answer depends on what you want to teach them with the match - to save for short term goals (the 529), or long term goals (the ROTH)? Or you could split and do both 50/50.

My father matched my contribution to a traditional IRA when I was a teenager working in a grocery store. I still have that account today, and it was one of several things that inspired me to always save for retirement even when I was in my late teens and early 20's. So it does work.

MasterStache

  • Magnum Stache
  • ******
  • Posts: 2912
Re: 529 vs Roth IRA
« Reply #7 on: November 22, 2016, 07:00:35 AM »
I recommend the Roth, unless there are significant savings on state income tax from using the 529.

529 accounts are always assessed as parental assets, rather than student assets, so your financial aid calculations award is penalized less.  Colleges want to make the student broke first, and then parents broke second.  But it doesn't really matter if you're planning to spend the money on college anyway, because you're going to spend every dollar in that account either way.

The Roth IRA is a retirement account, and is not assessed for financial aid calculations at all.  It's an excluded asset.

Roth IRA accounts can be tapped for college expenses at any time, without paying taxes or penalties.  The problem with using them for college is that the annual contribution limits are pretty small, and they cut into your ability to save for your own retirement if you use them for college. 

If the kids have earned income, they can set up their own Roth IRA in their own name, which can also be used for college expenses at any time without paying taxes or penalties, and you can fund it up to the amount of earned income they have, or the annual limit.  But if they were to fund it with their own money, there is very little benefit in it because they typically pay no taxes anyway, and the money won't sit there long enough to grow significantly more because of its tax deferred status than it would in a regular taxable investment account.

+1
 
We originally started funding 529 accounts. Then switched to Roth's for the very reasons Sol outlined.

 

Wow, a phone plan for fifteen bucks!