529 Plan vs. Roth IRA: Which Is Best For College Savings?

You already know college is expensive, so it’s a good thing there’s not one but several tax-smart ways to save for those costs. Two of the most common: Roth IRAs and 529 plans. So which is better for you?

To start, it’s worth noting that the rules for Roth IRAs and 529s are similar. (For this piece, we’re focusing on 529 savings plans, not prepaid tuition plans.) With either a Roth or a 529, you put money in after taxes, and your savings grow tax-free. As long as you follow the rules, you won't owe taxes on the investment earnings in either account.

For many savers, the Roth IRA is appealing because of its flexibility — these are retirement accounts, but you can always take out your contributions without penalty — and its wide array of low-cost investment choices.

Let’s break down the general virtues of the Roth IRA, and the situations in which a 529 plan can beat it.

Roths are for retirement — but they’re flexible

Roth IRAs were created to encourage people to save for retirement. But, unlike with other retirement accounts, you can always withdraw the Roth IRA money you have contributed, any time, free of taxes and penalties.

Note the emphasis on “contributed” there. If you withdraw the investment earnings in your Roth account before age 59½, you’ll likely owe income taxes and a 10% penalty on the money you take out of the account.

There are some exceptions: If you take out Roth money to pay for qualified college costs, then you won’t owe the 10% penalty. You will, however, owe taxes on any investment earnings you withdraw (unless you’re over age 59½ and have owned the account for five years or more).

You open a Roth IRA account at a broker, ideally a low-cost broker. Here’s more on how and where to open an IRA.

» Find the best IRA account for you

529s are for college (and K-12, too)

With a 529 plan, as long as the money you withdraw goes to qualified education costs, you won’t owe taxes or penalties. And the “qualified” costs can include private or religious tuition at elementary, middle or high schools.

But if the money goes to some other purpose, you may owe taxes and a 10% penalty on investment earnings. That means that, unlike with a Roth, you can’t simply bank those earnings for retirement if your child decides to forgo college.

The exception: If you end up with extra money in a 529, a portion can be rolled over to a Roth IRA in the 529 beneficiary's name. The rules allow up to $35,000 — as a lifetime cap — to be rolled over after the 529 account has been open for at least 15 years. Amounts rolled over are subject to Roth IRA contribution limits, so you won't be able to roll that full $35,000 over at once.

Other considerations when comparing 529 and Roth IRAs

If your state offers a 529 tax break and has a good 529 plan

We’ve listed which states offer 529 tax breaks. Generally, you'll want to take advantage of that tax break by investing in the 529 plan in your state. However, some 529 plans have high enough fees, or a thin investment selection, which could warrant selecting another state's option.

If you’re going to need financial aid

Roth withdrawals generally count as income in the Free Application for Federal Student Aid, or FAFSA, calculation, and having more income can put a bigger dent in how much aid your family gets. (Note that Roth IRA assets are ignored by FAFSA as long as the money is sitting in the account. It’s only the withdrawals that can cause financial aid pain.)

Meanwhile, 529s are sort of the opposite: While distributions from a parent-owned 529 won’t hurt financial aid, parent-owned 529 assets can count against you on the FAFSA, though the percentage hit for assets is much less than for income. (The rules are different for 529s owned by relatives who aren’t the beneficiary’s parents.) This is a pretty big win in favor of 529 plans.

If you’re above the Roth IRA limits

At higher incomes, you may encounter Roth IRA income limits that reduce the amount you can contribute or make you ineligible to contribute at all. The 529 plan doesn't have income limitations that guide who can contribute.

If you want to stash a lot of money away every year