529 vs. Roth IRA for college savings: Learn what's best

When it comes to saving for your child's college expenses, there's a good chance a 529 plan is the first tool you'll consider. The ability to pull out money tax-free for tuition and other costs makes these accounts a popular option.

However, college savings plans aren't the only way to save for higher education while catching a break from the IRS. Depending on your income, you also may be able to take money from a Roth IRA for qualified higher education expenses—without inflating your tax bill.

Which comes out on top in the 529 vs. Roth IRA matchup? Let's take a closer look at these two accounts and their key differences.

The 529 education savings plan is the go-to choice for many families with young children—and for good reason. These state-run plans allow anyone to contribute after-tax dollars to an account for a student's use. The savings grow without needing to pay taxes on the earnings, and money can be withdrawn tax-free when needed for qualified expenses such as tuition, fees, housing and more.

Aside from college costs, 529 plans also allow up to $10,000 a year to help cover K–12 tuition expenses. And any 529 money that isn't used to cover educational expenses can be transferred to an eligible family member of the beneficiary or—thanks to the SECURE Act 2.0—contributed into a Roth IRA for the beneficiary's future retirement use.

Roth IRAs are primarily designed to save for retirement rather than college costs, though they can be used that way. As with 529 plans, you contribute after-tax dollars to your Roth IRA account, your money grows tax-free, and you can take the money out for specific uses and at certain times without paying additional taxes, if criteria are met.

Typically, you need to wait until you reach age 59½ and have owned the account for at least five years before you can pull out earnings without incurring taxes or penalties. However, Roth IRAs have an exception for education that allows contributions to come out first with no tax or penalty. If you need to access earnings and it hasn't been five years and you're under age 59½, the earnings will be taxable. But it's still considered a penalty-free withdrawal when money is used for higher education.

Using a Roth IRA for college savings can be a clever way to create an all-in-one account that both helps you prepare for retirement and fund a student's education. In a head-to-head comparison, however, 529 plans tend to be the better option for your main savings vehicle, with a Roth IRA being a smart supplemental or alternative choice.

Here are the top differences that you'll want to consider:

The annual limit on contributions to a 529 plan is very high. Each state sets an aggregate limit—the total amount you can save—on its 529 plans, but these caps are typically around $300,000-500,000, which often is enough to cover the total cost of necessary training or a degree at many institutions.

However, gift tax return may come into play for anyone who makes large contributions to a 529 plan. Couples filing joint tax returns can give up to $34,000 a year, and single filers can give up to $17,000 per year, before needing to file a gift tax return. However, 529 plans can receive up to five years of gifts in a lump sum. That would make the limits $85,000 to single filers or $170,000 for joint filers.

By comparison, Roth IRAs have a low per-year contribution limit. Unless you start saving far ahead of time, you may not be able to store up enough in a Roth IRA to completely pay for a four-year degree.

• In 2023, you can contribute up to $6,500 a year if you're younger than 50, or up to $7,500 if you're 50 or older
• In 2024, you can contribute up to $7,000 a year if you're younger than 50, or up to $8,000 if you're 50 or older.

529 plans are not subject to any income eligibility.

However, Roth IRAs have income limits to participate.

• If you make between the maximum modified adjusted gross income (MAGI) listed, you can contribute but it will be a reduced amount.
• If you make equal to or more than the maximum limit listed, you can't contribute anything to a Roth IRA. If this applies to you, see these alternatives.

With a 529 plan, the account owner can choose from a menu of investment options for growing earnings—typically a mix of mutual funds or target-date funds. Usually the investment option is a designated portfolio based on age or risk tolerance. These choices can be dependable as far as your rate of return, but they're also relatively hands-off for the investor.

If you're looking for more involvement with your investment, Roth IRAs tend to offer options beyond funds, such as individual stocks, bonds and real estate investment trusts (REITs).

With a 529 plan, any amount you withdraw—whether it's your own contributions or investment earnings—is tax-free as long as it's used for post-secondary education expenses at any institution recognized by the U.S. Department of Education, whether it's vocational or collegiate. Up to $10,000 of the money even can be used for K–12 tuition expense every year.

With a Roth IRA your contributions come out first without tax or penalty and can be used for any reason, including for education expenses.*

Both Roth IRAs and 529 plans have tax benefits at the federal level. But the contributions you make to a Roth IRA won't reduce your state tax liability.

With 529 plans, however, most states offer tax deductions or credits for residents who put money into them. In some cases, these benefits are limited to contributions you make toward the state's own 529 offering, although many states offer a state tax deduction regardless of which state 529 plan was used.

Filling out a Free Application for Federal Student Aid (FAFSA) every year determines your student's eligibility for scholarships, grants and federal loans. The more income and assets you report on the FAFSA, the smaller the financial aid package typically will be.

A 529 plan owned by a dependent student or a parent is considered an asset, which can potentially reduce aid eligibility. However, the first $10,000 of 529 plan assets are exempt from those calculations, and only 5.64% of the amount over that counts toward your Student Aid Index and has the potential to decrease financial aid eligibility.

Roth IRA balances don't count toward your family's assets for the FAFSA. But it's important to realize that any amount you withdraw from a Roth IRA for college expenses will later qualify as income, and that may decrease financial aid eligibility. The FAFSA is based on your tax filings from two years ago, so waiting until the later college years to tap Roth IRA funds may help you reduce that impact.

While Roth IRAs offer more investment options, they also have a few more strings attached than 529s. State-administered college savings plans are available to all people regardless of income levels, have much higher contribution limits and can be used for expenses beyond higher education. This makes them a sound choice, but Roth IRAs shouldn't be discounted. Roth IRAs have more investment choices and won't count toward your assets under the FAFSA—plus any unused money still can be used for your own retirement.

Every family and student preparing for post-high school education expenses has different needs. A Thrivent financial advisor can take a look at your situation and recommend the savings avenues that make the most sense for you.