Drew: I want to save money for my child’s college education with the goal of having enough money to pay for 100% of her college costs. Should I open a 529 account or Roth IRA or some other account? What if she doesn’t go to college? I’m worried a 529 account is too restrictive.
I hear you, Drew. Who knows what the future will hold? You might see your daughter going to college, but depending on her interests and goals she may choose differently. Or, she may earn herself a full ride somewhere. Then what? Is a 529 plan a smart way to go?
Maybe. Personally, I opened a 529 plan for my son. He’s only two years old and who knows what he’ll decide to do with his life come 2032. But we’re rolling the dice and feeling confident that he’ll want to follow in his mom and dad’s footsteps and go to Penn State (hint, hint, nudge, nudge). But even if he opts to start a business or go straight into the workforce after high school we trust we can transfer the funds to another beneficiary. Maybe a future sibling? Maybe I’ll decide to go to cooking school and learn to do more than boil water for pasta?
And that’s the thing about 529s – the funds can be used quite flexibly and maybe more than one might assume. For one, you can change the beneficiary without consequence. If your daughter decides to forgo a higher education or doesn’t require the funds, you can change the plan’s recipient to another child, relative, friend, or even yourself if you have a hankering to go back to school.
The savings can also apply towards any eligible institution of higher education, or, simply, a school that participates in federal student aid programs. That’s a lot of places, including traditional colleges, trade, career or technical schools and community colleges. [This site can help you quickly look up a school’s 529 eligibility.] Many foreign schools qualify, too.
And while your daughter may not be set on going to college right away, she may warm up to the idea down the road or following a gap year [as Malia Obama is making so popular]. A 529 plan doesn’t have to get used as soon as your child graduates from high school. You can activate it at any time.
In the end, if none of the above ends up mattering to you or your daughter, you may need to withdraw that money for non-educational purposes and be forced to pay taxes and a 10% penalty.
If you think that’s likely, then the Roth individual retirement account (IRA), which you mention, may provide you with better options. We know the account more commonly as mainly a savings vehicle for retirement whereby you can make penalty and tax-free withdrawals starting at age 59 ½. So, assuming you’ll want money for retirement (and who doesn’t?), a Roth can be a fabulous way to save for those who qualify.
But, if along the way, your daughter needs money for college, then as an exception, a Roth IRA can also serve as a means to pay for qualified education expenses. You can withdraw your contributions (not to be confused with your investment earnings) from the account at any time tax and penalty free.
If your daughter doesn’t end up needing money for college, then that’s no problem. The Roth can go on to serve you in retirement still.
Yet another option is to just begin investing in an “Anything Goes” diversified brokerage account, which you can use for whatever you or your daughter will need years from now. The downside is you’ll have to pay capital gains tax on withdrawals.
Some parents also like using a “custodial account,” which is essentially a savings account that you, the parent, manage and control on behalf of your child until typically he or she reaches 18, 19 or 21 depending on the state. Whether you like it or not, the account irrevocably becomes your child’s property at that age (so, there’s that to think about.) If you were hoping your child would use that money for college and then she blows it on a new car (because she can), you might be wishing you’d gone in a different direction.
And finally, finally, you can always mix it up, right?
Creating a financial strategy that integrates all of above leaves you with a great deal of flexibility and covered bases. Maybe you save a little in a 529 to earn the tax benefit with the satisfaction in knowing you can always change the beneficiary, then open a Roth IRA because, well, you need money for retirement anyway…and last, save some in a brokerage and/or custodial account.
Diversifying your savings approach for your daughter’s future might create that balancing act you crave, knowing all the uncertainties ahead.
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Farnoosh Torabi is America’s leading personal finance authority hooked on helping Americans live their richest, happiest lives. From her early days reporting for Money Magazine to now hosting a primetime series on CNBC and writing monthly for O, The Oprah Magazine, she’s become our favorite go-to money expert and friend.