In case you haven’t realized it, college is EXPENSIVE! I mean like sell one of your kidneys expensive. Even worse is the cost of college continues to rise.
When I started college I accepted every college loan I could… I mean FREE MONEY! Right?!? The entire idea of letting an 18 year accept thousands of dollars of debt is INSANE, but it happens daily.
Entering my first year of teaching I was saddled with over $50,000 in student debt. Starting pay was just over $32,000… Enough said.
The burden of student loans is something I never want Sawyer to experience so we also knew we wanted to start some college fund.
The day we brought Sawyer home from the hospital we received a bag was full of goodies from the hospital. Diapers, coupons, and of course brochures about 529 plans.
I have to be honest, before Sawyer, I had no idea what a 529 plan was. Nothing a quick google search couldn’t solve…
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So what is a 529 plan?
Officially a 529 plan is a plan operated by a state or educational institution, with tax advantages to make it easier to save for college and other post-secondary training for your child or grandchild.
The best part is your investment grows tax free when used for qualified education expenses.
SWEET Donuts is this legal?!?
Sure is… See it’s even on the IRS’s website
Even better is a 529 plan has ridiculously high contribution limits…
A word of caution: While there is no official limit on the 529 plan, any contribution of $14,000 or more in single year may have gift tax consequences.
So lets take a doughnut break and review for a minute:
- Investment grows tax-free!!!
- Money can be with-drawn tax-free for education expenses!
I know what you are thinking…
“Why DIDNT you decide to start a 529 plan for Sawyer?”
Honestly there is nothing wrong with a 529 plan. Its a great way to save for college but there are some drawbacks.
For one, the funds can ONLY be used for education expenses.
“Well duh! Isn’t that why you started this fund?!?”
Yes thats true. The fund was started for college expenses. But what if you have excess funds in your 529? What if you don’t need the funds? What then?
The 529 plan limits what you can do with those funds without a penalty.
Some options are :
- Use the funds yourself for educational classes
- Roll the funds into another family members educational fund
Lastly you can pull it out, but you be will be taxed on the earnings plus a 10% penalty.
There are some ways on how to avoid the 10% penalty but that is for another post.
It is because of these drawbacks that we chose a Roth IRA instead of a 529 plan.
Yes, technically speaking a Roth IRA is intended to be a retirement account. Yet it can also be used effectively to save for college as well.
Like a 529 plan, a Roth IRA grows tax FREE!
Once you hit 59 1/2 any withdrawals are tax free.
DOUBLE Sweet donuts!!!
Side note: If you are not maxing this bad boy out each year you are losing out!!!
How can a Roth IRA be used to save for college?
There is a special rule that allows you to avoid any early withdrawal penalty from your Roth IRA. You can withdraw up to the amount you have contributed without paying taxes or penalties.
For example, lets say over 18 years I have contributed $100,000 to my Roth IRA. I can withdraw up to $100,000 at any point without any taxes or penalties. I can use it on college, a down payment on a house, anything regardless of age. Michelle can do exactly the same from her Roth IRA.
The benefit of using a Roth IRA versus the 529 plan is it allows us to have more flexibility over our funds. If Sawyer hits the scholarship jackpot, then we don’t have to touch our Roth IRA funds. Those funds continue to grow tax free and we never pay taxes on the money when we pull it out.
If our money was locked into a 529 plan, we would have to pay taxes on any withdrawals not used for educational expenses.
The Roth IRA isn’t perfect. The one major drawback on the Roth IRA is the contribution limits. Currently the limits are set at $5,500 per year. Michelle and I both can have our own accounts which allows us as a family to contribute $11,000 per year.
While this may not work for every family it works well for us. The biggest reason we selected the Roth IRA over the 529 plan was the flexibility it offers us as a family. It does not offer all the benefits such as high contribution limits but the tradeoff is having the freedom to use the funds as we please if we need to.
Questions for you:
What is your college savings strategy?
What were your reasons for selecting your strategy?