Can I Use a Roth IRA Instead of a 529?

Summary

Ramsey Everyday Millionaires Episode Summary: "Can I Use a Roth IRA Instead of a 529?"

Release Date: February 26, 2025
Host/Author: Ramsey Network
Hosts Featured: Dave Ramsey, Ken Coleman, Rachel Cruze, George Kamel, Jade Warshaw, and Dr. John Delony

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Introduction

In this episode of Ramsey Everyday Millionaires, the hosts delve into a common financial dilemma faced by parents: choosing between a Roth IRA and a 529 plan for funding their children's education. The discussion is sparked by a listener call from Eric in Chicago, who seeks guidance on optimizing his savings strategy for his son's college fund.

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Listener Inquiry

Timestamp [00:17]
Eric, a 49-year-old father with a 6-year-old son, shares his current approach to saving for college. He mentions consulting with two financial advisors—one recommended starting a 529 plan, while the other suggested a Roth IRA due to his age. Eric opted for a Roth IRA three years ago based on advice that he could withdraw the funds without penalties at age 59½ for college expenses, whereas a 529 plan would incur penalties if not used for educational purposes.

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Expert Analysis and Recommendations

Timestamp [00:56] - [03:03]
Financial expert C addresses Eric's concerns by highlighting the distinct advantages and limitations of both savings vehicles:

1. Roth IRA Considerations:

   • Flexibility: Roth IRAs offer the flexibility to withdraw contributions (not earnings) tax-free at any time, which can be advantageous for unforeseen expenses.
   • Primary Purpose: They are primarily designed for retirement savings, ensuring that funds are available tax-free when needed most for living expenses in retirement.

2. 529 Plan Advantages:

   • Purpose-Specific Savings: 529 plans are tailored specifically for education expenses, offering tax-free withdrawals when used for qualified educational purposes.
   • Penalty Implications: Withdrawals not used for education incur a 10% penalty on earnings, making them less flexible than Roth IRAs for non-educational uses.

Notable Quote [02:00]
C advises, "if you have the ability to invest and do both, I would do both. I would not necessarily do one or the other, if that makes sense."

Strategic Allocation: C emphasizes the importance of using the right tool for the right job. He suggests continuing to max out the Roth IRA as part of a broader investment strategy (referred to as "baby step five"), while also allocating additional funds to a 529 plan specifically for the child's education. This approach ensures that retirement savings remain intact while dedicating separate funds for educational purposes.

Notable Quote [02:37]
C explains, "So, yeah, 100. That's why I say the right tool for the right job."

Flexibility of 529 Plans: C further elaborates on the adaptability of 529 plans, noting that beneficiaries can be changed to grandchildren or other relatives, and excess funds can be converted to an IRA at the yearly contribution limit, thereby mitigating potential penalties.

Notable Quote [03:01]
C states, "You can change the beneficiary. So if you have a grandkid on down the road... they can convert it to an IRA at the yearly rate."

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Conclusion and Takeaways

Timestamp [03:35] - [03:37]
Eric expresses his appreciation for the advice, acknowledging the practicality of utilizing both a Roth IRA and a 529 plan to optimize his savings strategy. The hosts conclude the call by reinforcing the idea of using each investment tool for its intended purpose to maximize financial benefits and minimize penalties.

Key Takeaways:

• Dual Strategy: Utilize both Roth IRAs and 529 plans to diversify and safeguard savings for retirement and education.
• Purpose Alignment: Ensure each savings vehicle aligns with its primary purpose—Roth IRAs for retirement and 529 plans for education.
• Flexibility and Adaptability: Take advantage of the flexibility inherent in both accounts, such as changing beneficiaries and converting excess funds appropriately.
• Maximize Contributions: Continue to maximize contributions to each account type based on individual financial capabilities and goals.

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By thoughtfully allocating funds between a Roth IRA and a 529 plan, parents like Eric can effectively plan for both their retirement and their children's education without compromising on either front. This balanced approach not only ensures financial security but also offers flexibility to adapt to changing circumstances.

Transcript

[A]

This episode is brought to you by SmartVestor. Connect with an investing pro near you at RamseySolutions.com SmartVestor let's get to Eric in Chicago. Eric, how can we help?

[B]

Hey guys, thanks for the call. I was just calling to make sure I'm on the right track. I'm trying to save my son for a college fund. I've seen a couple of financial advisors and one of them told me to start a 529 fund and another one I talked to said start just a Roth IRA because I'm a little bit older. So I ended up doing that three years ago. And he said since I'm older, I could withdraw that money at 59 and a half with no penalties if I wanted to use it for his college. And if he doesn't go to college and I had a 529 plan, I'd have a penalty. So you think that might be the right direction to go?

[C]

I mean, he's definitely right about the fact that you could withdraw it without penalty versus the 529. If it's not used for school expenses, then there would be a penalty 10%. So the question is, how old are you?

[B]

I'm 49. My son's 6.

[C]

Okay, your son is 6. Okay. There's part of this where I like using the right tool for the right job. Because when you're, when you're investing in your Roth, obviously you're limited on the funding there and there's a good chance that you're going to want that specific money that you're able to withdraw tax free in retirement for the purposes of you living. And you would want to be able to add a certain amount of money for kids college, I would not want you to. I guess what I'm getting at is I would not want you to invest less just so that it's in a Roth. Does that make sense? Like if you have the ability to invest and do both? I would do both. I would not necessarily do one or the other, if that makes sense.

[B]

So, okay, yeah, I've been maxing it out for the last three years.

[C]

Right. And if you've been maxing it out and that's part of your normal 15, the 15 off of your gross income, I would continue to do that because baby step six, or I'm sorry, baby step five, where you're investing for kids college is in addition to that 15. So if you have the ability to invest whatever you choose to, I mean, I'm not saying it has to be a large Sum. It could be, I don't know, 200amonth. But if you decide to put more in for education, I would do it in a 529. So that at least you're having, like this is my nest egg over here and this is for papa. And then I've got kids college over here. Does that make sense?

[B]

Yeah, it does. Yeah. Yeah. Okay. I didn't know you could have both.

[C]

So, yeah, you can do. Yeah, 100. That's why I say the right tool for the right job. And the truth is. Yeah, that 529, you don't want to overfund it. Listen, if you did, there's worse things that could happen in the world. Worst thing that happens is you take it out and you pay the penalty and you have a lot more money than you had before.

[A]

You think it's so broad that you can use it for some type of learning.

[C]

You can.

[A]

Am I right? Like, it's pretty broad.

[C]

It's pretty broad. It pat. You can change the beneficiary. So if you have a grandkid on down the road and you say, okay, I can. Whatever Junior didn't use, I can pass it on to. To grand Junior and that person can use. Right. So you have the ability to change who it's for. And over time, if they want to take it and there's extra money in there after education, they can turn it around and they can convert it to an IRA at the yearly rate, if that makes sense. So if it's 7, $500, they can contribute that much and transfer it year after year. Does that make sense?

[A]

Yeah, totally.

[B]

Yeah, it does make sense, you know. Yeah. Good question.

[A]

Eric, thank you so much for the call.