If you would like to start saving money for your child’s college education, or if you have been thinking about going back to college yourself, you have several options. A college savings plan allows you to make contributions to an account that automatically pays out when the beneficiary of the account reaches college age or attends college. A Roth IRA is a second practical alternative that allows you to save for college expenses.
How a Roth IRA Works?
A Roth IRA serves the same purpose as a traditional IRA – both encourage Americans to save money for retirement. The main difference between a Roth and a traditional IRA is that the former is funded with income that has already been taxed, while the latter is funded with pre-tax income. Generally, you must open a Roth IRA directly through a financial institution because many employers only offer traditional IRAs to employees.
How a College Saving Plan Works
Offered through your state, college savings plans provide a means of putting away money specifically for future educational expenses. Like a Roth IRA, state college savings plans are generally funded with after-tax dollars and the earnings grow tax-free until withdrawn. Tuition plans work a little differently. With a tuition savings plan, you purchase credits for tuition and other college expenses up front and then use the credits to pay your expenses at participating state colleges.
Roth IRA Versus College Savings Plan
A Roth IRA and a college savings plan offer the same basic savings methods and withdrawal options, but the plans differ when it comes to contribution limits. With a Roth IRA, an individual may contribute up to $5,000 per year, as of 2011, with no lifetime maximum. With a college savings plan, an individual can contribute any amount to the plan each year, although amounts exceeding $13,000 will be taxed as a gift. In addition, college savings plans may have lifetime limits that vary by state.
College Savings Plan Versus Tuition Plan
As with a college savings plan, you do not lose the money in a tuition plan if a dependent chooses not to attend college. If the credits purchased in the tuition plan are not used, the money you contributed to the plan pays out to you, along with any interest accrued on your investment. The benefit of a tuition plan over a college savings plan is that the credits you buy represent a percentage of college expenses rather than a dollar amount, so you lock in current prices for future educational expenses.
- Piggy Bank with college graduation cap image by Paul Hill from Fotolia.com