An IRA and a 529 are two ways to save for college.
It's never too soon to start saving for your child's college education, particularly with tuition costs steadily increasing. In addition to traditional savings accounts, there are a variety of investment vehicles available that can help you make the most of your money. Two of these options are an IRA and a 529 plan. Before investing in one of these types of accounts, it's important to understand how they differ and what benefits they may offer.
Types
There are two distinct types of 529 plans: a college savings plan and a prepaid tuition plan. According to the U.S. Securities and Exchange Commission (SEC), college savings plans may be used to pay for education expenses at approved postsecondary schools. Prepaid tuition 529 plans may be used at approved elementary, secondary and postsecondary schools.
You may also use a Roth IRA to pay for qualified education expenses or an Education IRA, also known as a Coverdell ESA.
Beneficiaries
A 529 college savings or prepaid tuition plan may be established for any beneficiary, regardless of age. You may open a 529 plan to pay for education expenses for your child, grandchild, other relative, family friend or even yourself. A Roth IRA may also be used for education expenses for yourself or another student, regardless of age. An Education IRA or ESA, however, may only be established for minor children, and contributions are prohibited once the beneficiary reaches age 18.
Contribution Limits
IRAs and 529 plans differ greatly in the maximum amount you may contribute. As of 2010, the Internal Revenue Service allows you to contribute a maximum of $5,000 per year to a Roth IRA or $2,000 per year to an Education IRA, so long as you do not exceed the limit for adjusted gross income. Contribution limits for 529 plans are regulated by each state. According to Saving for College, some states have lifetime maximum contribution limits of $300,000 or more.
Investment Options
The range of investments available also differs significantly with an IRA versus a 529 plan. According to The Motley Fool, an IRA offers more investment choices, including stocks, bonds, mutual funds, CDs and money market account. With a 529 plan, your investment options are typically limited to a much smaller pool of mutual funds. Most 529 plans only allow you to change your investment choices once per year.
Tax Considerations
Withdrawals from a Roth IRA, Education IRA or 529 plan are tax free, so long as funds are used for qualified education expenses such as tuition, books, fees, or room and board. Contributions to these types of plans are also tax free. According to The Motley Fool, some states may also offer a tax deduction for contributions to a 529 plan. If you use funds in an IRA or 529 for expenses other than education, be prepared to pay a 10 percent withdrawal penalty in addition to regular income tax on the distribution.
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