Roth IRA Or 529 Plan To Pay For College: Comparing The Pros And Cons

One of the main questions that has come out of my 529 savings guide by age post is whether to contribute to a Roth IRA or a 529 plan to pay for college. This is a great question I did not think about because contributing to a Roth IRA is not something I have ever done due to maximum income limitations.

Fortunately or unfortunately, by the time I worked a full year in finance, I was no longer eligible to contribute to a Roth IRA due to the income limit requirement. Instead, I just focused on maxing out my 401(k) every year for the next 13 years until I left full-time work for good.

Partly due to my inability to contribute to a Roth IRA, I developed a negative bias towards the investment vehicle. It made no sense to me why the government would set arbitrary income limits for retirement savings. I believed everybody deserved to save efficiently for their future. Further, the article is a nice counterpoint to the 99% positive Roth IRA articles out there.

Now that I'm older, wiser, and have two children to consider, let's take a look at the pros and cons of contributing to a 529 plan or a Roth IRA for college. I'll also share some thoughts on which route is best for you.

Positives Of A 529 Plan For College

A 529 plan is a dedicated college and grade school savings plan that offers special tax advantages when used for education. Here are the main positives of contributing to a 529 plan.

1) Tax Advantages

The main positive of the 529 plan is that the money contributed to the plan can grow tax-free like the Roth IRA.

When money is withdrawn, the account holder does not have to pay any taxes if the money is used for qualified education expenses.

Qualified education expenses typically include tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible education institution. Room and board can potentially be included as well for full-time students.

Starting in 2018, up to $10,000 per year from the 529 plan can be used for K-12 education expenses such as private school tuition and tutoring.

One of my regrets is not contributing to a Roth IRA when I was working at McDonald's or during my first year working in finance. If I had, I probably would have over $200,000 in my Roth IRA today.

2) State Income Tax Deduction

So far, over 30 states and the District of Columbia offer a state income tax deduction if you contribute to a 529 plan. The income tax deduction ranges from $1,000 to $10,000.

Unfortunately, California, Delaware, Hawaii, Kentucky, Massachusetts, Minnesota, New Jersey, North Carolina, and Tennessee have state income taxes and do not offer a state income tax deduction or tax credit for contributions to the state's 529 college savings plan.

Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming do not have state income taxes, therefore, they do not offer 529 plan contribution state income tax deductions.

3) Generous Contribution Limits

The 529 plan contribution limits are quite generous. The limits should be enough to cover the average cost of a 4-year public or private university tuition.

Every state's 529 plan allows for maximum contributions of at least $235,000 per beneficiary. Georgia and Mississippi have the lowest maximum balance limits at $235,000, followed by North Dakota at $269,000.

Idaho, Louisiana, Michigan, South Carolina, Washington state, and Washington DC have maximum limits of $500,000. While on the absolute highest end, Pennsylvania's limit is $511,758, New York's limit is $520,000 and California's limit is $529,000 for 2021. These limits will adjust over time due to inflation.

To reach a $500,000 contribution limit over 18 years requires an average contribution of $27,777 a year. Therefore, I think we can agree that these contribution limits are quite high, especially once you factor in potential returns.

These contribution limits apply to each beneficiary. For example, in California, which has a $529,000 maximum contribution limit, a set of parents contributing $500,000 for a beneficiary and a set of grandparents also contributing $500,000 to the same beneficiary would not be allowed.

4) Easy To Change Beneficiaries

If your child turns out to be a gifted athlete like Michael Jordan (The Last Dance documentary is amazing) or a genius like Albert Einstein, he or she might get a full-ride, rendering your 529 plan contributions unnecessary. Your child might also decide not to go to college, which is becoming a wiser and wiser choice in this digital age.

In either case, you can easily change the 529 beneficiary to someone else in your family tree. Qualified family includes the beneficiary's siblings, parents, children, first cousins, nieces and nephews, among others.

An example of a lateral change. You have established 529 savings accounts for your son Bob and daughter Nancy. Bob gets a full scholarship for football with room and board paid as well. You can shift Bob's 529 funds to Nancy's 529 plan. If there is money left over from Nancy's plan, you can shift the remaining balance to your nephew.

An example of an upwards change. When your son Michael graduates from college, $100,000 is left in the 529 plan. You can transfer the $100,000 upward to your name to use towards a Masters degree in online marketing.

Just be aware that some states have restrictions on account ownership changes. Check with your own state before transferring just to be sure.

529 Savings plan ownership transfer restrictions by state - Roth IRA or a 529 pla

5) Reasonable Flexibility

If you are lucky enough to have a child get college grants/scholarships, you can withdraw up to the amount of that grant/scholarship penalty-free. You’ll still have to pay taxes on the earnings (any investment gains from your original contributions). But that just means you’ll have gotten tax-deferred growth in the meantime.

6) A 529 Plan Is A Wealth Transfer Tool

If you accumulate too much money in your 529 plan, you can always use it as a generational wealth transfer tool. In fact, if your estate is going to surpass the death tax threshold limit, opening up multiple 529 plans to fund your future generations is a fantastic tax-efficient idea.

7) You can roll over leftover 529 funds into a Roth IRA starting in 2024

Due to the passage of the SECURE 2.0 Act, you can now rollover leftover 529 funds into a Roth IRA starting in 2024. The rollover limit per year is the same as the Roth IRA contribution limit, $6,500. And you can only roll over a maximum $35,000 into a Roth IRA for now. Further, your 529 plan needs to be open for at least 15 years.

Here are more details about rolling over leftover 529 funds into a Roth IRA. The post also discusses who benefits the most from the new rollover benefit.

Negatives Of A 529 Plan For College

Here are three negatives of a 529 plan.

1) Penalties and Taxes

If you don't use the 529 plan money for qualified education expenses, then you'll pay a 10% penalty on your gains. You'll also be subject to income taxes on the gains and may even have to pay back any state income tax deductions you previously claimed.

If you received a state income tax deduction for your contributions, you may have to pay that contribution back as well.

Thankfully, only the earnings will be taxed and penalized. Your contributions are safe no matter what you do.

2) Opportunity Cost

Whatever you contribute to your 529 plan is money not contributed or spent elsewhere. Imagine living like a pauper for 18 years because you wanted to contribute $27,777 a year to your daughter's 529 plan and she turns out hating you, hating school, and not wanting to go to college? What a bummer!

Now imagine she was an only child. With no younger sister, you might have to look for someone you don't even really know in your family tree to transfer the funds.

This type of situation happens all the time. It's important to carefully assess your child's personality, intellectual ability, and belief about college while contributing to his 529 plan. Don't be a robot.

529 savings by ag guide - Roth IRA or a 529 pla

3) Limited Investment Options

Just like the 401(k), your investment options are limited to the plan you choose. Hopefully, you will choose a plan that has low-fee investment options. Target-date funds are popular in 529 plans, but they may carry higher fees.

If you go the actively managed fund route, hopefully the portfolio manager or team of analysts will at least perform in-line if not better than its benchmark index. Unfortunately, most active fund managers underperform their respective indices.

Positives Of A Roth IRA For College

Like the 529 plan, a Roth IRA holder contributes after-tax money. The money then gets to compound tax-free. If money is withdrawn after age 59.5, 100% of the withdrawal is tax-free.

You can withdraw up to the amount you've contributed without taxes or penalties at any time and for any reason. For example, if you contributed $100,000 to your Roth IRA and it has grown to $250,000, you can withdraw $100,000 any time without consequence.

You can also withdraw the earnings penalty-free, but not tax-free if the Roth IRA money is used for college expenses for you, your spouse, your children, or your grandchildren.

1) More Flexibility With A Roth IRA

The number one reason why you would want to save in a Roth IRA over a 529 plan is the flexibility. Nobody knows the future with certainty. For example, maybe in 10-20 years all college tuition will be free. I bet there's a 30% chance of this happening. Saving too much in a 529 plan would end up being a suboptimal financial decision.

It is generally better to put on your seat belt first and save for your retirement, and then save for your child's education. You don't want to end up old, broke, and unable to provide for your children. Eventually, you will want to stop working so hard and saving so much.

With a Roth IRA, you have more flexibility with how you want to use the funds. If your retirement is on track, especially if you've been maxing out your 401(k) and saving in a taxable brokerage account, then you can direct the money to your child’s education.

In addition to using your Roth IRA for college tuition, you can also use a Roth IRA for a house down payment. Every parent should consider encouraging their child to work and set up their own Roth IRA.

The other type of flexibility you have with a Roth IRA is the flexibility to invest in many more types of investments. Over the long run, investing in a low-cost index ETF will likely save you a bunch of money.

2) A Roth IRA Isn't Counted For Financial Aid Purposes

A final positive about saving in a Roth IRA for college is that it doesn't count when you apply for financial aid. Neither are your other retirement accounts such as the 401(k) or traditional IRA.

If you're rich enough to send your kid to college, but not rich enough to not feel the pain of paying for tuition, then having a Roth IRA may be better than a 529 plan. So many folks fall in this in-between category. The middle class really is getting squeezed.

When colleges analyze your family's finances, it will count a portion of your 529 plan amount to determine how much aid you may receive. If your child has an $800,000 529 plan, chances are slim-to-none he or she will get any free financial aid.

Despite the benefit of the Roth IRA not being considered in financial aid calculations, I hope none of you will intentionally adopt a poverty mindset that depends on others for financial help. Adopt an abundance mindset so you don't have to depend on anybody for aid.

Besides, only 5.64% of your savings is counted on the FAFSA. While supposedly up to 50% of your income is counted. Hence, if you want to game the college financial aid system, have less income and more of your assets in tax-advantaged retirement accounts.

Negatives Of A Roth IRA For College

Here are the biggest negatives of a Roth IRA.

1) Not Everybody Can Contribute

For 2023, the modified adjusted gross income for singles must be under $153,000 to be eligible to contribute to a Roth IRA. There are phaseout contribution amounts at various income levels.

Once you're over $153,000 for singles and $228,000 for married couples, you can no longer contribute to a Roth IRA. These income limits tend to go up by 1-2% a year to account for inflation.

Roth IRA income and maximum contribution limit 2021
[Roth IRA income and maximum contribution limit 2021]

If you end up getting a job in an expensive city such as San Francisco or New York City, you could easily earn over $140,000 within the first three years of employment. Cities are expensive because incomes are high.

It makes no sense to deny someone the ability to contribute to a Roth IRA just because they ended up working in a high-cost of living city.

2) The Maximum Contribution Limit Is Low

You can only contribute a maximum of $6,500 to a Roth IRA in 2023 if you are under 50. If you are over 50, you can contribute $7,500 to a Roth IRA for 2023.

This is up from $5,500 in 2019. $6,500 is better than a poke in the eye, but it's going to take many years and a decent compound growth rate to build a large enough portfolio to pay for college and retirement.

I've also written up different ways to pay for college beyond a Roth IRA or 529 plan as well. One of the ways is actually paying from your income while your kids are attending college. I never though of this as a retiree since 2012. Blind spot!

3) Withdrawals Count As Income

When you withdraw from your Roth IRA to pay for college, the withdrawal counts as income. Given income is the largest determinant in the financial aid process, you may eliminate any possibility of free aid.

For example, let's say your family makes $75,000 a year in household income. This level of income for even one child often qualifies a family for free financial aid. In fact, some private schools will pay 100% of tuition if a family earns less than $100,000 a year.

But if you withdraw $35,000 from your Roth IRA, you suddenly make $110,000 for the year and could be disqualified for free tuition.

Below is a list of the top colleges that provide 100% need-based scholarships. We're talking free tuition to most households who earn less than $100,000 – $150,000 a year.

  • Amherst College
  • Bowdoin College
  • Brown University
  • Colby College
  • Columbia University
  • Davidson College
  • Harvard University
  • Northwestern University
  • Pomona College
  • Princeton University
  • Stanford University
  • Swarthmore College
  • University of Chicago
  • University of Pennsylvania
  • US Air Force Academy
  • US Military Academy (West Point)
  • US Naval Academy
  • Vanderbilt University
  • Washington and Lee University
  • Yale University

Financial Aid Examples From Various Colleges

Below are more financial aid examples from various colleges that provide loan-free aid.

College financial aid examples - Roth IRA or a 529 pla

Strategically, if you find yourself at the income borderline for getting free money, wait until your child’s last year of college to withdraw money from a Roth IRA.

This strategy may help you get more aid at the expense of paying for the initial years with non-529 plan money. However, you may negatively affect a younger child from getting free aid. Do the math.

4) Puts Your Retirement At Risk

Any Roth IRA money used for college is not being used for retirement. Earlier Roth IRA withdrawals rob the money's ability to compound over time. On the flip side, if you withdraw the money right before a bear market, then you're actually saving money.

529 Plan Or Roth IRA To Pay For College?

The ideal scenario is if you can max out your 401(k), max out your Roth IRA, and contribute $15,000 a year in your child's 529 plan. Your goal should be to utilize each tax-advantageous account for its respective intended purposes.

If you can only choose to build a 529 plan or a Roth IRA to pay for college, here's what you should consider:

Focus on building a Roth IRA to pay for college if:

  • You don't have children yet, but plan to
  • You are behind in your retirement savings
  • You are not sure if your kids will attend college
  • Your kids have the potential to get free tuition due to academics, athletics, or other talents
  • You don't want to work until you're 60+
  • You believe college will become cheaper over time or free
  • You are eligible, as many people are not
  • You plan to make more in retirement than while working

Focus on building a 529 plan to pay for college if:

  • You are already contributing to a Roth IRA and other retirement plans
  • You are confident your kids will go to college and/private grade school
  • You are happy with your occupation and plan to work for a very long time since you won't have a Roth IRA to help you in retirement
  • You make more than the Roth IRA contribution income limits
  • You have two or more children to whom you can transfer beneficiaries just in case the full 529 plan amount is not used

At the end of the day, if your child has earned income, opening a custodial Roth IRA is a no-brainer. The maximum amount contributed to a Roth IRA ($6,000 for 2021) will be tax-free since it below the standard deduction limit. The money gets to compound tax-free each year. After five years, it can then be withdrawn tax-free as well.

Recommendation To Plan For College

Better plan for college by sign up for Empower, the web’s #1 free wealth management tool to get a better handle on your finances. In addition to better money oversight, run your investments through their award-winning Investment Checkup tool to see exactly how much you are paying in fees.

I was paying $1,700 a year in fees I had no idea I was paying. I’ve been using Personal Capital since 2012 and have seen my net worth skyrocket during this time thanks to better money management.

Recommendation To Diversify Your Investments For College

Investing in stocks and bonds to pay for college is fine. However, I suggest also investing in real estate to pay for college. Real estate is a more stable assets that provides utility and generates cash flow. Most of the wealthiest people in the world own real estate.

If you can't or don't want to buy a rental property, then invest in private real estate for the long run. My favorite private real estate investment platform is Fundrise. Fundrise invests primarily in single-family and multi-family homes in the Sunbelt, where valuations are cheaper and net rental yields are higher.

I've invested $810,000 in private real estate to earn more passive income and diversify away from my expensive San Francisco real estate holdings. Investing in real estate is a great way to benefit from inflation and positive demographic trends.

Related Posts:

Why I Never Contributed To A Roth IRA, But Why You Probably Should

Should I Do A Back Door Roth IRA? Pros and Cons

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58 thoughts on “Roth IRA Or 529 Plan To Pay For College: Comparing The Pros And Cons”

  1. Very timely for me, as I have finally gotten around to figuring out this whole college thing.

    My conclusion: a 529 is just a worse Roth.

    Your listed negatives are a bit strange.
    1) The income limits are a mirage, as everyone has mentioned the backdoor Roth IRA is well known (after a 401k pretax max, naturally).
    2) The $6k Roth IRA limit is also not real. Put in an additional $38.5k per person through the Mega backdoor (set it up through a solo 401k or lobby your HR HARD to offer this.)
    3) A 529 contributes 5.64% to the FAFSA whereas a Roth is invisible. Have your kid take out all loans and pay them off the day she graduates with Roth conversion money.

    Why even have taxable brokerage when assets held in a Roth shield quarterly dividends and interest from tax? I’m going all in on Roth as a couple putting in $6k + $6k + $38.5k + $38.5k per year… and will just pay college out of it after the fact. Two maxed out 401ks and HSAs and a DCFSA on top of that, and I’m pretty much tapped out, with any extra going towards the mortgage, because… FAFSA.

  2. Any thought on using the mega backdoor Roth as an alternative to 529 for older parents? This would overcome the contribution limit with a normal Roth (backdoor included). And if parents turn 59.5 before kids start college, they can withdraw to fund the cost of school without penalty.

  3. Sam, loved the content on your website – great depth and easy-to-follow explanations!
    Wanted to get a clarification w.r.t Roth IRA usage for education.
    You mentioned under “Positives Of A Roth IRA” that “You can withdraw up to the amount you’ve contributed without taxes or penalties at any time and for any reason”.
    Under “Negatives Of A Roth IRA”, you mentioned “When you withdraw from your Roth IRA to pay for college, the withdrawal counts as income”.
    I assume the amount contributed won’t count as income, only the earnings would, right?

  4. I’m a California resident, have two small kids, and want to contribute for their college. What plan do you recommend? Should I stay in state? I heard Utah’s plan is good?

  5. I always invested money in my own retirement accounts just in case my son didn’t go to college. Then when he did enroll in college I just funded the 529 plan a week before tuition was due in September 2016 and took the $20k tax deduction. I did this again for 2017, 2018, 2019, and then in January 2020. $100k deductions during my highest income years saved me a lot.

    1. Hi, Peter.
      I wasn’t quite able to follow the part after you funded the 529 a week before tuition was due. How did funding a 529 from your retirement account get you a $20k deduction?
      Apologies if I’m missing something basic.

  6. We have both a 529 and an IRA for our three kids. At 18, each kid will have around $110K in the 529’s which is enough to pay for a state school. My 19 yo has chosen a state school and has 30K in his IRA which he won’t need for college so that money can go towards a downpayment or a jump on retirement.

    Paying kids to work at a small business is GREAT. The IRA allows the kids more flexibility if they choose (and get in) to go to a more expensive school.

    1. Nice! Sounds like you saved an appropriate amount.

      One of the reasons why I want to keep Financial Samurai is exactly for that reason: to teach them about the internet, writing, communications, business development, marketing, etc and pay them to work and help them fund a Roth IRA when they aren’t paying taxes. A trifecta win!

  7. Thanks Sam and great article. Many of us face a material amount of college costs on the horizon. It is defiantely a hot political issue that could result in changes. As the price of college continues to increase, with more folks questioning the overall need, that could impact innovation to our country in the years ahead.

    Someone one said to me “you can finance college but you can’t finance retirement”.

    1. Let’s hope tuition inflation slows down as the value of college declines. It makes no sense that tuition inflation continues to rise faster than overall inflation!

      Good quote!

  8. Papa Foxtrot

    One thing I always wanted to know is why are 529 plans only designed for higher education? Why not set it up so when children come to age at 18 they could use it to chase enterprises such as a business. Or is there a plan/way to use similar money?

  9. Hey Sam,

    If I save up and my kid gets a full ride or doesn’t go to college, and there’s no one else eligible to pass the 529 to, can it be “sold” to avoid the 10% penalty?


  10. Great post and many thanks!!! Any opinions on using a 401k vs a Roth 401K (not all employer plans offer).

    Trying to figure out if I should invest in a 401k Roth and Roth IRA or 529 or maybe a traditional 401k and Roth IRA or 529. Thanks.

    1. I definitely wouldn’t use a 401(k) to fund a child’s education. I’d keep those pre-tax contributions untouched until 59.5+.

      In general, it’s good to keep the accounts separate and used for its intended purposes. I hear from so many people who have underfunded their retirement accounts when they are in their 50s and 60s due to too much pilfering of those accounts.

      1. I should have been more clear in my original question. We’re older parents so will be 60+ plus before we’d need the money for college.

        1. Interesting position to be in! If you are are allowed to take out any amount of money you want, it is definitely possible to fund both retirement and college if you were able to aggressively fund it during the 30+ years prior. But you would have to make the calculations, be conservative, and make sure you have enough till a ripe old age, with some left over for good measure.

  11. I found that the 529 was more beneficial in my case since the NY plan one gets a nice state deduction every year. This greatly helps ever since the SALT was taken away.

  12. Thanks Sam! Great topic and analysis. As for maxing FAFSA aid and shielding assets (and ignoring any moral questions about doing so), I had this idea around using a Roth IRA and a home equity loan to pay for college. Simply, you use a HELOC to pay for college throughout or until the final year you have to pay for. Then use the Roth IRA contributions to pay off the HELOC.

    You are limited to using contributions because paying off a HELOC is not a qualified withdrawal. And this requires that you have a lot of contributions that you may have otherwise used for retiring before 59.5. But for people who contribute $6K every year (+ spouse’s $6K) and may have access to a Mega Backdoor Roth (401k after-tax conversion) where they can add an additional $20K-$30K every year, it may be a good option I think. Thoughts?

    1. Hmmm, never thought of that! So, take out a HELOC to increase indebtedness to make yourself look better on the FAFSA, and then use a nice juicy Roth IRA to pay the HELOC. Seems reasonable. But, HELOC rates are higher than normal mortgage rates, so they are relatively not that attractive. I guess you would take out a HELOC at the last most possible to pay the least amount of interest.

      Somehow I feel it’s better to just focus on making more money so as to not bother with the HELOC route.

  13. What about opening a ROTH in the kids name and contributing to that for them as a gift? Essentially setting them up for some college funds OR retirement, whichever is more vaulable to them when they make their own life decisions.

      1. Is it possible to “hire” your kid and pay him 6kish a year with 100% contribution into the Roth IRA? Just a hypothetical… XD

  14. Hi Sam,

    What do you think of IUL as a vehicle to pay for college? I’ve been advised to use that since there isn’t much tax benefit for me for 529 and I’m not eligible for Roth IRA. I’ve been studying about IUL but still can’t figure out if that makes sense for college saving. I have about 10 years to college.

    1. Milind Patel

      I’m not a fan of IUL. But a properly designed whole insurance policy with a lower base premium and higher paid-up addition can be a great tool for not only college expenses but other aspects of life as well. Look at all the riders to take full advantage of a policy.

    2. IUL is not a good idea. Search this in google and read the reddit post: “ Indexed Universal Life Insurance”.

      TLDR It’s too expensive and not worth it.

    3. Funny enough, I’m doing a deep dive on life insurance products now and just wrote about Index Universal Life and its pros and cons here. I don’t think it’s a bad idea if you’ve got the cash flow, are wealthy, and are already maxing out all the tax-advantageous retirement accounts available to you.

      1. Thank you Sam. My financial advisor used an analogy between the IUL and an investment property: both need your down payment and monthly payment, and both give you a big chunk of money after certain number of years. But the benefit of IUL is more flexible in terms to take out wash loans and tax benefit. I’m deciding between buying an investment property or an IUL, to either pay for college in 10 years or to supplement retirement. The advisor said they could achieve same financial gain, but rental needs a lot of work, and IUL is completely passive.

        Do you agree with that?

  15. Always enjoy your in-depth research analysis Sam! Thank you. We were on the same boat/scenario you are talking about here. When we had to choose between 529 vs Roth IRA we chose Roth for few reasons. Income was not high enough to contribute to both and what if kids were to get scholarships. But as our income grew over the years we still didn’t open a 529, the argument was, there were only few more years left and the contributions will not grow by much. A BIG mistake. Now my kid is ready to go to college and was accepted to great colleges but we get $0 need-based scholarships and the merit-based ones are fiercely competitive and the cost of college is over $50k/year min. With all the uncertainties going on in the world/job market, we are hesitant to withdraw from Roth. I wish we started a 529 when we could afford to contribute even if there was only 4/5 years left to college as we could have 1.saved more, 2.captured the stock market bull run in 2018, and 3.keep the money growing until end of college (8/14 yrs) .

    1. Thank you for your perspective Lalani.

      I do wonder how I would feel having to draw down for a Roth IRA to pay for expensive college in this market. It would annoy me to have to sell any S&P 500 index shares if they are down between 10-30%.

      Competition truly is fierce. Where does your kid want to go?

  16. Sam really appreciate all your posts, I know they take a lot of digging in and diving deep. I used to deal with the Income Thresholds with a Roth IRA but learned about a back door Roth IRA which has allowed me to contribute to a Roth. Hope this helps.


      1. Sam, can you elaborate on why you are not a fan or ROTH IRAs for people in the 24% and higher tax bracket? I’m in the max tax bracket, and I max out my backdoor ROTH every year. This is after maxing out my 401K, and investing a bunch in post-tax accounts. I just wish I could put more in my ROTH.

        I agree if the choice is between 401K and ROTH – 401K is the better option, but after the 401K is maxed, ROTH is the next best thing (much better than post-tax investments).

        1. Sure. Say you pay a 37% federal income tax rate on your $700,000 in income.

          You retire at 60, and income tax rates stay the same.

          To earn $700,000 in retirement income and continue to pay a 37% federal tax would require having $17,500,000 in capital at a 4% rate of return, or $35 million in capital at a 2% rate of return.

          It’s definitely possible, but here’s the key point: Most people make LESS in retirement while not working than while working.

          Related: Roth IRA: Not All Is What It Seems

          1. Agree with everything you said – but still don’t agree that is a disadvantage of ROTHs.

            For my situation – I’m already maxing my pre-tax 401k – I have no other pre-tax investment options. All of my other investments will be post tax.

            That leave regular brokerage accounts – stocks, bonds, mutual funds, ETFs, … which will be invested post-tax, and I will pay some taxes yearly on gains and distributions, then more taxes when I sell those assets (capital gains) at some rate depending on my income.

            I also have the option of a ROTH. The money is post-tax when it goes in, but there are NEVER any more taxes on it. Not yearly, not when I sell, not when I take money out. And there are no RMDs, and it doesn’t count as income for other purposes (healthcare subsidies, etc…).

            ROTHS are looking pretty good to me!

            1. Sounds good to me. This is why we have a market.

              I would personally never pay 37% in federal taxes up front + state taxes, but you and others are and that’s fine. It is good to support the government now and we as a society do need it, especially with deficit spending.

              You may want to consider starting a consulting business to get some tax shields and earn income more efficiently.

              Then you can go down the rabbit hole and contribute to a SEP IRA and Solo 401(k) too ($100K+ in pre-tax contributions).

              I can write more about earning income more tax efficiently if there is enough demand.

            2. Yes, being a W2 employee and counting on that for your main source of income does suck when it comes tax time. You end up paying a whole bunch in taxes. Hopefully I only need to put up with it for a few more years, then I can control my sources of income (and tax treatment) better in retirement.

      2. I’m curious why you wouldn’t take advantage of the backdoor Roth. I don’t see it as an either or decision. I fully contribute to my 401K to get the maximum tax deferral and then contribute to a backdoor Roth. This extra $6K gets to grow tax free forever vs. being saved in a taxable brokerage or 529 – I don’t see the downside. Am I missing something?

  17. I don’t dispute any of the math here, but if you have $800,000 saved in a 529, why on Earth would you be worried about free financial aid?

  18. The Roth IRA is one of the most valuable vehicles to park money in (the only thing that beats it in my mind is putting money in an HSA if you treat it like a stealth IRA (it has the potential to have triple tax advantage of not taxed going in, no tax on growth, and no tax on withdrawal if used for qualified medical expense).

    A Roth IRA has the contribution taxed but after that growth and withdrawal is untaxed, thus making it extremely valuable. I think it would be a waste of these funds to fund college as you withdraw it fairly early and miss out on decades of tax free growth.

    Even as a physician with a high income I manage to get money into a Roth account via backdoor IRA method. Even though I get hit with a higher tax rate now, the contribution is fairly small because of annual limit so the actual tax dollar amount is quite low. Then in retirement I can hopefully draw off a much bigger pot with no tax implication at all.

      1. I’m not sure I’m aware of that, can you elaborate? The backdoor ROTH contribution I do I thought was the only option I had to get money into a ROTH account after income limits exclude me from contributing directly.

        1. Set up your own solo 401k with after-tax contributions and in-service withdrawals enabled?
          Viola. Mega backdoor.

      2. Hate, hate, hate, hate, hate, hate…. cash value life insurance plans. The only ones making money is the person selling it to you.

        1. Milind Patel

          Yes – it’s a front loaded plan. But a properly designed mutual policy (more PUA and less base premium) can be a great saving tool for many people. Especially also when you can add waiver of premium rider and terminal illness rider. With those two riders it essentially also acts as a disability insurance policy as well as long term care policy. Cash value life insurance gives you an ability to earn uninterrupted compound interest and it’s a play on arbitrage since it’s considered tier 1 capital. It’s definitely a long term plan that gives you living benefits as well as tax free wealth transfer to your beneficiaries. Disclaimer – I’m not a life insurance agent.

          1. Thanks Milind,

            I’ve had the mindset of keeping insurance as insurance and investments as investments. For investments, I need to know the fees involved, historical rates of return, investment philosophy, and tax treatments. For insurance plans (other than term), I can never get a straight answer on any of these. Add in all the penalties for early default, and I just don’t understand them. As Buffet says, don’t invest in something you don’t understand.

            1. Totally fair. I hear you man. It was a frustrating experience for me as well trying to dig up all information and making sense of it. Also I don’t view it as an investment, but more like a storage tank for my money to make capital efficient over a long term period with permanent tax free death payout as a side benefit for my heirs.

  19. Let’s not forget the backdrop Roth contribution, effectively opening up Roth additions for those high earners.

      1. I had a taxable IRA and knew about the pro rata rules if I had done a backdoor Roth IRA move if left as is.

        However to get around it you can roll your traditional ira into a 401k before the end of the year you do the backdoor. Then you don’t get hit with pro rata taxes.

  20. Nice post Sam. I did this deep dive about a year ago when my second child was born with the same outcome. We both max the Roth and will likely supplement with 529 post day care years as we intend to utilize public schools. I like the flexibility of the Roth as long as our income allows us to contribute

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