Practitioner’s Tax Action Bulletin® Advisory
When it comes to saving for a child’s college education, many people assume they should use a qualified tuition program (QTP), also known as a 529 plan. However, there may be an alternative strategy – a Roth IRA. Both QTPs and Roth IRAs offer tax-advantaged ways to save for the future: contributions are made with after-tax dollars, earnings grow tax-free, and qualifying distributions are not taxed. Nonqualifying distributions from both accounts are subject to income tax and a 10% penalty (subject to certain exceptions). But there are also key differences that can make one option more appealing than the other depending on individual circumstances. Could the unconventional use of a Roth IRA make sense for you?
Contributions
Who can Contribute. Anyone can contribute to a QTP, including parents, grandparents, or the beneficiary (i.e., future student). Only the account owner can contribute a Roth IRA.
Annual Contribution Limit. Roth IRA contributions are limited to the lesser of $7,000 for 2025 ($8,000 if over age 50) or earned income and are subject to phase-out if income exceeds certain thresholds. So, high-income taxpayers may be ineligible to make Roth IRA contributions.
Unlike the Roth IRA, QTP contributions are not subject to an income limitation, making them attractive to high-income earners. QTP contributions made by someone other than the beneficiary are considered taxable gifts, subject to the annual exclusion of $19,000 in 2025 ($38,000 for a married couple). A special election allows larger contributions to be spread over a five-year period, allowing for a total gift of $95,000 in one year ($190,000 for a married couple) without any gift tax consequences.
Overall Contribution Limit. While there is no annual limit on QTP contributions, total contributions cannot exceed the beneficiary’s estimated higher education costs, typically calculated as five years of undergraduate tuition, fees, room, and board at the most expensive school covered by the program. Thus, each state plan may have a different limit. But, given the cost of undergraduate education, these limits tend to be quite high.
In contrast, there is no limit to how much money can be accumulated in a Roth IRA, however the lower annual contribution limits can slow down the account’s growth compared to a QTP, where larger contributions are possible.
Tax-free Distributions
QTP distributions are tax-free if used to pay the beneficiary’s qualified higher education expenses in the same tax year. This includes tuition, fees, books, supplies, computer equipment, software, room, and board for students attending at least half-time. QTP funds can also be used for up to $10,000 per year of elementary or secondary school tuition.
On the other hand, a Roth IRA is designed to save money for retirement, with qualified distributions available after age 59½ provided the account has been open for at least five years. Because some people are choosing to start families later, some account holders may reach 59½ when their kids are in college, allowing them to take qualified distributions to help cover educational expenses.
If funds are needed from a Roth IRA before age 59½, prior contributions can be withdrawn for any reason without tax or penalty, since they were made with after-tax dollars. Ordering rules generally provide that contributions are distributed first, then earnings. So, income tax and penalties on early withdrawals used for education (or any other purpose) won’t apply until all contributions have been distributed tax-free.
If earnings from a Roth IRA are withdrawn to pay for qualified education expenses for the account owner or their family before age 59½, the 10% penalty can be avoided. However, these earnings are still subject to tax. Thus, using a Roth IRA’s earnings for education costs isn’t ideal. A Roth IRA is best when the distributions needed before age 59½ are limited to the original contributions.
Note: Qualifying education expenses are similar for QTPs and Roth IRAs, except that elementary and secondary school tuition is not a qualifying expense exempt from the 10% penalty for Roth IRAs.
Unused Funds
One major advantage of using a Roth IRA to fund college expenses is its flexibility. After the account holder reaches age 59½, they have full access to the funds. This flexibility may be appealing to parents deciding between saving for retirement or saving for their child’s education. It’s also beneficial for those unsure if their child will attend college. If the money is not needed for school, it can continue to grow tax-free for retirement.
In contrast, there are limited options to avoid taxes and penalties on the earnings of unused QTP funds. Another family member can be named as a beneficiary, or up to $10,000 can be used to repay student loans for the beneficiary or their sibling. Some nonqualified QTP distributions avoid the 10% penalty, such as distributions when the student receives scholarships or claims education credits, though earnings are still subject to tax.
Beginning in 2024, up to $35,000 can be rolled over from a QTP to a Roth IRA in the beneficiary’s name. While this option is promising, there are a few things to keep in mind. First, the IRA will be in the beneficiary’s name, so the original contributor will not have access to the unused funds. Also, if there is more than $35,000 left in the QTP, the account owner must find another qualified use for the excess funds, or risk paying taxes and penalties on the earnings. Amounts rolled over are subject to the annual Roth contribution limits (but income limits are waived), the QTP must’ve been open more than 15 years, and the rollover cannot include any amounts contributed in the past five years (including earnings on those contributions). Note that changing the beneficiary of a QTP likely starts a new 15-year period.
Impact on Financial Aid
When determining need-based financial aid eligibility, both student and parental assets and income are considered. An advantage of using a Roth IRA is that the account balance doesn’t count as an asset for the Free Application for Federal Student Aid (FASFA). On the other hand, a QTP’s value, whether owned by the student or their parent, is included as a parental asset that can diminish aid eligibility. If the QTP is owned by someone else (e.g., a grandparent), it is not reported on the FAFSA.
Financial aid income calculations are based data from two years prior. For example, the 2025-26 academic year’s eligibility is determined using 2023 income. Roth IRA distributions are included in these income calculations, potentially affecting future aid. In contrast, QTP distributions aren’t included if the account is reported as an asset on the FASFA. If not reported as an asset, however, QTP distributions are included in the income calculations.
Other Considerations
State Tax Benefits. Many states allow a tax deduction or credit for QTP contributions, often favoring their own state’s plan. There are generally no comparable state tax benefits for Roth IRA contributions.
Investment Choices. QTPs, run by states or educational institutions, typically have limited investment options. Roth IRAs allow taxpayers to invest in almost anything – stocks, bonds, mutual funds, and even real estate. This allows the taxpayer to pursue more aggressive growth early on and shift to safer investments as college approaches. It’s also important to compare account fees for both types of accounts.
Interaction with Education Credits. Tax-free QTP distributions must be reduced by any qualifying expenses used to claim education credits (i.e., no double-dipping). There is no similar rule for Roth IRAs, meaning educational expenses paid with Roth IRA funds can also be used to claim education credits.
Savers Credit. Taxpayers with income below a certain threshold may be eligible for a nonrefundable credit up to $1,000 for Roth IRA contributions. However, this credit is unavailable to children under age 18, full-time students, or dependents.
Summary
Both QTPs and Roth IRAs offer tax-advantaged ways to save for higher education, but there are key differences. QTPs, with higher contribution limits and no income restrictions, may be an attractive choice for high-income earners or those who wish to save substantial amounts for education expenses. Roth IRAs provide flexibility to use funds for retirement if not needed for education. The best choice depends on factors like income, availability of other resources, and investment preferences. For some, a coordinated strategy using both a QTP and Roth IRA will maximize benefits while saving for both education and retirement.
Editor’s Note: The full article presented above is available in the Practitioner’s Tax Action Bulletin, as National Tax Advisory Memo (NTA -1265), Issue 11, first published June 4, 2024, along with other valuable tax practitioner articles. Contact our sales team for a subscription to Checkpoint’s bi-monthly Practitioner’s Tax Action Bulletin, which is available in print, and online or to add Thomson Reuters Planner CS to your advisory toolkit.
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