• Matt Morizio

College planning part 1: Is the 529 your only choice?


Spoiler alert: The 529 savings account may not be your best option for college savings.

Why?

As a professional financial advisor – and a father of “five under six” – I don’t suggest a 529 college savings account as my first choice. Or second. That’s because, in my opinion, 529 programs have distinct disadvantages over other investment options.

-Many 529’s have high fees. Parents should take a hard look at what they’ll be paying in administrative costs for 529’s. Sometimes those fees aren't justified by the investments within the 529.

-Withdrawals are inflexible. If you use the money for something other than a college education – if your child decides against college, for example – you’ll be taxed on the earnings and pay a 10 percent penalty.

-A 529 plan offers limited investment options and may not allow owners to adequately diversify their funds.

So if a 529 plan isn’t for everybody, what might be a better option?

How about a Roth IRA?

A Roth IRA is primarily a retirement vehicle. You deposit after-tax money (just like a 529), and earnings accumulate tax-deferred (just like a 529). When you reach age 59.5, your entire withdrawal is tax-free (provided you have owned the account for five years).

Since your contributions are made with after-tax money, you can always withdraw those contributions for any purpose without incurring taxes or penalties.

Consider this scenario:

You and your spouse begin contributing to your Roth IRAs (you can each have one, subject to income limits) after the birth of your first child. You each contribute $5,500 per year (the limit for 2018) until your child reaches 18.

Assuming an average annual return of 8 percent, the combined account values after 18 years are roughly $445,000 – $198,000 of which can be withdrawn tax and penalty free for ANY reason.

That will put a good dent into any four year college tuition.

And don’t forget about the other $247,000. Earnings continue to accumulate until you withdraw at retirement, tax free - not a bad retirement/education vehicle.

One final point - unlike a 529 plan, the balances in a parent’s Roth IRA are not considered an asset on the federal college financial aid forms – very important when calculating eligibility.

I dive into more detail in Part 2 here.

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Investment advice offered through Beck Bode, LLC, a fee-only Registered Investment Advisor in the Greater Boston area.