Whether to choose a 529 or a Roth IRA to fund education expenses

By Michael D. Koppel, CPA (Retired)/PFS/CITP, MBA, Gray, Gray & Gray LLP, Canton, Mass.

Sec. 529 plans have been available to help plan for children's or grandchildren's post-secondary education for over 20 years. Each state has slightly different investment and other rules. Sec. 529 plans are great vehicles for saving, as the income in the plan is tax-deferred (Sec. 529(c)(1)) and qualified distributions are tax-free (Sec. 529(c)(3)(B)). Additionally, if the designated beneficiary does not use the funds, the beneficiary can be changed to other qualified family members (Sec. 529(c)(3)(C)).

Contributions to a Sec. 529 plan are treated as a completed gift to the beneficiary (Sec. 529(c)(2)(A)). Individuals making contributions to a Sec. 529 plan can take advantage of a special provision that allows them to use five years of the annual exclusion for gifts at once (Sec. 529(c)(2)(B)). The law known as the Tax Cuts and Jobs Act of 2017, P.L. 115-97, made changes that allow Sec. 529 funds to be used for "enrollment or attendance at an elementary or secondary public, private, or religious school" (Sec. 529(c)(7)). However, qualified distributions for those purposes cannot exceed $10,000 per year.

Recently, various articles have discussed which was better for education planning — a Sec. 529 plan or a Roth IRA (see, e.g., Becker, "The Pros and Cons of Using a Roth IRA for College Savings," Mom and Dad Money (1/23/18), available at momanddadmoney.com. Roth IRAs provide more flexibility than 529s, since distributions do not have to be used for education expenses, even though saving for college may have been the purpose of establishing the Roth IRA. While distributions from Roth IRAs can be used for higher education while avoiding early withdrawal penalties, there are restrictions.

However, another option is available for grandparents to help pay for their grandchildren's education. For more than 35 years, Sec. 2503(e) has allowed an unlimited payment of tuition as long as the money is paid directly to the school. Tuition payments made directly to the school, unlike Sec. 529 contributions, will not be treated as gifts. However, unlike contributions to a Sec. 529 plan or gifts to a child so they can open a Roth IRA, the assets remain in the grandparents' hands, increasing the taxable gain when they are sold and the proceeds are used to pay the tuition.

So what is the best way for a grandparent to help pay higher education expenses? As with most things in tax or gift and estate planning, it depends. The first consideration when determining when and how much a grandparent should help with a grandchild's education (or any other gift) is to make sure the grandparents have enough assets left to pay their living expenses for the remainder of their lives (life expectancy in the United States has increased by approximately 1.5 years in the last 15 years). It is also important to remember that the current bull market (as determined by S&P averages) is the second longest in history, with the third-highest returns as calculated on Fortune's website. It is unlikely the bull run will last forever. How would a potential bear market affect the grandparents' assets? This calculation also needs to account for inflation.

So what should the grandparents do? Consider the following examples:

Grandparents with no monetary issues: In this situation, assisting with a Roth IRA and paying tuition directly would maximize the help they can provide their grandchildren. Even if the grandparents should die, the new higher estate and gift tax exemption likely would eliminate any estate tax (the exemption for 2018 is $11,180,000, or $22,360,000 for a married couple).

Grandparents with limited assets but who can assist with either a 529 or a Roth:In these situations contributions should be made to the 529. However, the question of whether it should be used for primary and secondary school is an issue. It must be remembered that, in theory, the longer an investment is held the greater the gains.

The questions of gift and estate planning, including education planning, need to be discussed with qualified planners.


Michael D. Koppel, CPA (Retired)/PFS/CITP, is a retired partner with Gray, Gray & Gray LLP in Canton, Mass.

For additional information about these items, contact Mr. Koppel at 781-407-0300 or mkoppel@gggcpas.com.

Unless otherwise noted, contributors are members of or associated with CPAmerica International.

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