What I really enjoy about the Roth IRA is the flexibility it offers over the 529 plan. I have two teenagers of my own, and I've been contributing to their 529 plans since they were in diapers. I've always told them to shoot for the best schools, but as my children are now in high school, I've come to realize that my expectations for them may not precisely mirror their own hopes and dreams. One of my kids is working hard to get into a top-notch university, but my other child may not attend college at all.
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Unfortunately, any money I've saved in the 529 plan that is not used for educational expenses will not only become fully taxable as ordinary income but will also be subjected to a 10 percent penalty.
Many states offer a tax deduction for funds contributed to a 529 plan. If you reside in such a state, the 529 can be an attractive solution. But for the millions who live in the eight states that don't offer this tax break—including California, Massachusetts and New Jersey—the Roth IRA is both a terrific and flexible alternative.
Unlike a 529 plan, a Roth IRA allows people who have funds left over after withdrawing for college expenses to convert those dollars to retirement income—with no tax consequences or penalties whatsoever. Simply, this means that if Johnny or Jane doesn't use up all of the funds to pay for college, the remaining bucks can be used to supplement your own retirement income.
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Roth IRAs do have some drawbacks. First, there are contribution limits. For 2014 the maximum you can contribute is $5,500, or $6,500 for people age 50 and older. Second, you need to have earnings in order to contribute, making it virtually impossible for retirees to participate. Third, people with high incomes are prohibited from using this great tax tool. For a single taxpayer whose income exceeds $114,000, the Roth is phased out. For married folks the phase-out begins at $181,000.
The most widely touted college savings tool is the 529 plan, which clearly has merits and should be considered. But for many Americans, ignoring the Roth IRA as a college savings technique is an unfortunate mistake.