No matter if you’re saving money to pay for college for yourself or a child, it’s important to use the right account so you get as many benefits as possible. Laura answers a listener question about whether he should use an IRA or a 529 plan for the best results.
Most states offer at least one 529 plan; however, the fees and benefits, such as the maximum contribution limit and investment options, vary. Unlike an IRA, some 529 plans allow you to save over a quarter million dollars with no annual caps. So do your homework and compare plans across the country using a site like Savingforcollege.com.
As long as the funds in a 529 plan are used to pay for qualified education expenses, such as tuition and room and board, the earnings in the account are not subject to federal or, in most cases, state tax.
As long as the funds in a 529 plan are used to pay for qualified education expenses, such as tuition and room and board, the earnings in the account are not subject to federal or, in most cases, state tax. Plus, some states offer tax deductions or credits for residents who choose in-state plans.
You can even have both a 529 prepaid plan and a savings plan. The prepaid account would pay for tuition and the savings plan could be for other expenses, such as room and board, books, supplies, and computer equipment.
IRA or 529 Plan—Which is Better for College Savings?
Due to all the benefits that come with a 529 plan, it gets my vote for the best account to save for college. Distributions get favorable treatment because unlike with an IRA, they're not a factor in the calculation for the following year's financial aid eligibility. This is the case no matter if a 529 plan is owned by the student or a parent.
The only drawback is that if you use 529 funds for anything other than qualified education expenses, those distributions will be subject to income tax, plus a 10% penalty. So never contribute more to a 529 than you believe your child will need for the total of his or her education expenses.
To sign up for a 529 you can go directly to the plan manager or use a financial advisor. Using an advisor may cost a little more, but may be worth it if you’re new to investing.
Free Resource: Retirement Account Comparison Chart (PDF download)—get the rules for the most popular retirement accounts
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