Roth vs 529 for College Savings with 6 year timeframe

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Topic Author
ldd4774
Posts: 17
Joined: Wed May 08, 2019 5:24 pm

Roth vs 529 for College Savings with 6 year timeframe

Post by ldd4774 »

Hi everyone, a little late to the game for college savings but I think I finally have some of my savings in order so we can start moving some of our extra money to college savings.

I have twins age 12 who are 6 years from attending college. I expect both of them to go to University and I am okay with them having loans. Both my wife and I are college educated and believe in post secondary institution.

I am 47, wife is 44. We both work and max out our 401K plan. We are in the 22% bracket and have not saved for any college savings at this point. We have been moving toward building up our emergency fund, paying off our home equity line and maxing out our 401K which we finally achieved this year. All of our investments are in 401K Savings and currently around 700K.

I have about $1000 a month to invest in either a Roth or 529. Currently have neither set up. Our income is not over ROTH limits and both my wife and I can contribute to a ROTH this year and likely every year moving forward.

I have been doing some research and Roth seems the way to go since we likely have not met our financial retirement goal. The pros I like about the ROTH is that I can let the money grow until we need it for retirement or college. I am also concerned that with current market, 6 years until college in a 529 is not enough time to allow investments to grow or risk downturn, although I could look at it as 11 year horizon if I add 4 years to college and take out money when market is at a good selling point.

I also read that having money in ROTH instead of 529 may increase our chances of getting low interest/interest free loans or more scholarships.

The downside to ROTH is that if I need money in 6 years for college, I will be 53, so while I can take money out, the amount will be taxed. Again, even if I wait to pay off large chunk of college in the 4th year, I will be 57 and the money will still be taxed since I read the cutoff to take ROTH tax free is 59.5.

I live in MA, so small state tax deduction up to $2000 per family for 529 purposes. I would at a minimum put $2000 into Fidelity MA 529 to maximize this gain but should I put the rest into 529 or start funding ROTH with the rest?

The plan is to try to work our way to invest more into ROTH/529 as we grow older while maxing 401K as we are able to. We will likely still have a big balance to pay for college no matter what route we choose. Depending on the type of loan the kids receive when they are in college, we are comfortable with the kids carrying the loan or we could funnel some of the money we contribute to our 401K to paying off college (last resort).

I am leaning towards putting $2000 into 529, then the rest into ROTH.

Any advice or input is appreciate. Thanks
Last edited by ldd4774 on Thu Aug 27, 2020 3:25 pm, edited 1 time in total.
KlangFool
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Re: Roth vs 529 for College Savings with 6 year timeframe

Post by KlangFool »

ldd4774 wrote: Thu Aug 27, 2020 12:57 pm

The downside to ROTH is that if I need money in 6 years for college, I will be 53, so while I can take money out, the amount will be taxed. Again, even if I wait to pay off large chunk of college in the 4th year, I will be 57 and the money will still be taxed since I read the cutoff to take ROTH tax free is 59.5.
ldd4774,

That statement is not true. You can take the Roth IRA contribution out tax-free and penalty-free for any reason at any time. The money that you have to pay tax and penalty before 59.5 years old is the Roth IRA's earning.

In your case, you should max up you and your spouse's Roth IRAs.

KlangFool
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shess
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Re: Roth vs 529 for College Savings with 6 year timeframe

Post by shess »

ldd4774 wrote: Thu Aug 27, 2020 12:57 pm The downside to ROTH is that if I need money in 6 years for college, I will be 53, so while I can take money out, the amount will be taxed. Again, even if I wait to pay off large chunk of college in the 4th year, I will be 57 and the money will still be taxed since I read the cutoff to take ROTH tax free is 59.5.

I live in MA, so small state tax deduction up to $2000 per family for 529 purposes. I would at a minimum put $2000 into Fidelity MA 529 to maximize this gain but should I put the rest into 529 or start funding ROTH with the rest?
The state-tax benefit seems pretty clear, just make sure you scope out the absolute savings to see if that's worth it to you. From what I see online, it's a flat 5%, so you'd max an extra $100/year.

Note that you can withdraw your original contributions to Roth at any time. The taxes and penalties you reference only apply to EARNINGS. So one play would be to just use the Roth as a parking place for funds, and hope for lots of earnings that you can leave in there after withdrawing the contributions.

Personally, if you're in a position where you have to choose, I'd lean towards Roth, because if you put the money in the 529, you WILL think "This money needs to be spent on education". Like if your kid has two choices, and prefers the more expensive one, will your family think "Well, we have this money set aside for education, so go for it"? I don't mean to say that you should always choose the cheaper choice, but in going to college there are a LOT of unknowns, so I think having a bit of friction on the financial side is a good thing.
smitcat
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Re: Roth vs 529 for College Savings with 6 year timeframe

Post by smitcat »

I agree with Klang.
Are you sure you are in the 24% bracket and you can still fund the Roths ?
Topic Author
ldd4774
Posts: 17
Joined: Wed May 08, 2019 5:24 pm

Re: Roth vs 529 for College Savings with 6 year timeframe

Post by ldd4774 »

KlangFool wrote: Thu Aug 27, 2020 1:01 pm
ldd4774 wrote: Thu Aug 27, 2020 12:57 pm

The downside to ROTH is that if I need money in 6 years for college, I will be 53, so while I can take money out, the amount will be taxed. Again, even if I wait to pay off large chunk of college in the 4th year, I will be 57 and the money will still be taxed since I read the cutoff to take ROTH tax free is 59.5.
ldd4774,

That statement is not true. You can take the Roth IRA contribution out tax-free and penalty-free for any reason at any time. The money that you have to pay tax and penalty before 59.5 years old is the Roth IRA's earning.

In your case, you should max up you and your spouse's Roth IRAs.

KlangFool
Thanks for clarification!
Topic Author
ldd4774
Posts: 17
Joined: Wed May 08, 2019 5:24 pm

Re: Roth vs 529 for College Savings with 6 year timeframe

Post by ldd4774 »

smitcat wrote: Thu Aug 27, 2020 1:24 pm I agree with Klang.
Are you sure you are in the 24% bracket and you can still fund the Roths ?
Thanks for comment. Yes, still eligible. I am in lower range of 24% income and I see ROTH is MAGI 203,000 filing jointly. Thanks!
Buy_N_Hold
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Re: Roth vs 529 for College Savings with 6 year timeframe

Post by Buy_N_Hold »

I am a big fan of the Roth route because of the flexibility it gives you for spending the funds. With the 529, you are locking yourself into educational expenses down the road, and there are so many things that could happen between now and then. Just my two cents!
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teen persuasion
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Re: Roth vs 529 for College Savings with 6 year timeframe

Post by teen persuasion »

I also read that having money in ROTH instead of 529 may increase our chances of getting low interest/interest free loans or more scholarships.
The logic behind this is that on the FAFSA retirement account balances are not included in Available Assets, but 529 balances are included. Assets are assessed at 12% (plus a large portion of income), and a progressive rate is applied. The top rate is 47%. So 47% of 12% of Assets gives the oft repeated figure of 5.64% max of assets included in the Expected Family Contribution, or EFC.

If you are truly in the 24% bracket (can't quite reconcile that with eligible for direct Roth IRA contributions), your income will be the larger issue for need based aid.

You can also run contributions thru a 529 to get the tax deduction during college years: put it in, get deduction, take it out to pay bills, rinse, repeat. Sounds like a minimal tax break here in any case.
humblecoder
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Re: Roth vs 529 for College Savings with 6 year timeframe

Post by humblecoder »

It definitely makes sense to contribute to the 529 account to maximize the state tax deduction. As far as putting the remaining college savings into a 529 or Roth IRA, I would suggesting reading this: https://www.investopedia.com/529-plan-v ... ge-4771260 and this: https://www.savingforcollege.com/financ ... avings.php

Some key points about using a Roth to save for college:
1. Retirement accounts, such as a Roth, don't count as assets in the financial aid formula. However, your Roth withdrawals will count as income for financial aid purposes in the following year. Income counts MORE than assets in terms of ability to pay for college and get financial aid. 529 savings count as parental assets, so it is treated more favorably than income when it comes to financial aid. See below for a potential workaround.

2. You can only withdraw your contributions tax free from a Roth until you reach 59.5. Earnings are taxed. However, 529 withdrawals for education are not taxed at all.

I would consider just contributing all the money to a 529 directly if you think that all the money is going to be used for college. It sounds like it will, based upon the fact that you said that will likely have a shortfall in savings for college. 529 is optimized for education spending, so why not use the right tool for the job?

If you want to hedge your bets because you might decide to use some of the money for retirement, then another option would be to contribute to the Roth IRA but don't withdraw from it while your kids are in college - take out loans instead. Then once they graduate, withdraw the money from the Roth and use it to pay down the loans. This would allow you to save money for college in the Roth and not impact financial aid.
tashnewbie
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Re: Roth vs 529 for College Savings with 6 year timeframe

Post by tashnewbie »

ldd4774 wrote: Thu Aug 27, 2020 1:41 pm Thanks for comment. Yes, still eligible. I am in lower range of 24% income and I see ROTH is MAGI 203,000 filing jointly. Thanks!
The phase out range for direct Roth IRA contributions for MFJ is $196k to $206k MAGI for tax year 2020 (top limit was $203k for tax year 2019). See: https://www.irs.gov/retirement-plans/pl ... e-for-2020

Remember, MAGI is before the standard/itemized deductions. So bottom of the 24% tax bracket for MFJ for 2020 is about $171k, which means MAGI of at least ~$196k (after $24,800 standard deduction is added). All that to say, if you're MFJ and in the 24% tax bracket, it's highly unlikely that you qualify to contribute the full amount directly to a Roth IRA ($6k or $7k if over 50).
Topic Author
ldd4774
Posts: 17
Joined: Wed May 08, 2019 5:24 pm

Re: Roth vs 529 for College Savings with 6 year timeframe

Post by ldd4774 »

Sorry, I looked at my gross income, not taxable income. I am indeed in 22% tax bracket and qualify for ROTH. Thanks for clarification.
solargod007
Posts: 33
Joined: Sat Jun 20, 2020 2:52 pm

Re: Roth vs 529 for College Savings with 6 year timeframe

Post by solargod007 »

ldd4774 wrote: Thu Aug 27, 2020 12:57 pm Hi everyone, a little late to the game for college savings but I think I finally have some of my savings in order so we can start moving some of our extra money to college savings.

I have twins age 12 who are 6 years from attending college. I expect both of them to go to University and I am okay with them having loans. Both my wife and I are college educated and believe in post secondary institution.

I am 47, wife is 44. We both work and max out our 401K plan. We are in the 22% bracket and have not saved for any college savings at this point. We have been moving toward building up our emergency fund, paying off our home equity line and maxing out our 401K which we finally achieved this year. All of our investments are in 401K Savings and currently around 700K.

I have about $1000 a month to invest in either a Roth or 529. Currently have neither set up. Our income is not over ROTH limits and both my wife and I can contribute to a ROTH this year and likely every year moving forward.

I have been doing some research and Roth seems the way to go since we likely have not met our financial retirement goal. The pros I like about the ROTH is that I can let the money grow until we need it for retirement or college. I am also concerned that with current market, 6 years until college in a 529 is not enough time to allow investments to grow or risk downturn, although I could look at it as 11 year horizon if I add 4 years to college and take out money when market is at a good selling point.

I also read that having money in ROTH instead of 529 may increase our chances of getting low interest/interest free loans or more scholarships.

The downside to ROTH is that if I need money in 6 years for college, I will be 53, so while I can take money out, the amount will be taxed. Again, even if I wait to pay off large chunk of college in the 4th year, I will be 57 and the money will still be taxed since I read the cutoff to take ROTH tax free is 59.5.

I live in MA, so small state tax deduction up to $2000 per family for 529 purposes. I would at a minimum put $2000 into Fidelity MA 529 to maximize this gain but should I put the rest into 529 or start funding ROTH with the rest?

The plan is to try to work our way to invest more into ROTH/529 as we grow older while maxing 401K as we are able to. We will likely still have a big balance to pay for college no matter what route we choose. Depending on the type of loan the kids receive when they are in college, we are comfortable with the kids carrying the loan or we could funnel some of the money we contribute to our 401K to paying off college (last resort).

I am leaning towards putting $2000 into 529, then the rest into ROTH.

Any advice or input is appreciate. Thanks
I liked Matt Becker's posts on this topic here: https://momanddadmoney.com/resources/
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