Smart College Savings Strategies: 529 Plans, Roth IRAs, and More

As of 2024, the average total annual cost of attendance (including tuition, fees, room, and board) is approximately $28,130 per year, or $112,520 for a four-year degree. This figure blends costs across in-state public, out-of-state public, and private institutions based on national enrollment trends. (Source: College Board, National Student Clearinghouse)

These costs are expected to continue rising at a rate of 4–6% annually. With numbers like these, it’s more important than ever to plan ahead.

Time Value of College Savings – How Much to Save

If the average total cost of college is $28,130 per year (including room and board), that equals $112,520 for a 4-year degree. Here’s how early savings impact what you need to set aside annually:

Starting Age	Years to Save	Annual Savings for Full Goal	% of Goal Funded if Saving $3,100/year
Age 1	17 years	$3,100/year	100%
Age 5	13 years	$4,850/year	~64%
Age 10	8 years	$8,800/year	~35%

📌 This example assumes steady annual contributions, 7% compounded growth, and no withdrawals during the saving period. The earlier you start, the more time your money has to work.

Understanding Financial Aid and Its Impact

• When families apply for financial aid via the Free Application for Federal Student Aid (FAFSA), the assets and income of both the student and parents play a role in determining eligibility.
• Parent assets (like 529 plans, brokerage accounts, and bank accounts) are assessed at a rate of up to 5.64%.
• Student-owned assets (like UTMA/UGMA or custodial brokerage accounts) are assessed much more heavily—20%.
• Parent-owned retirement accounts (401(k)s and IRAs) are not counted as assets on the FAFSA.
• Withdrawals from retirement accounts, however, do count as income in the year they occur and may reduce aid eligibility two years later.
• Parent income is also a significant factor and typically weighs more heavily than assets.
• 💡 The 5.64% figure is not a tax or penalty—it’s the portion of parental assets the FAFSA formula assumes can be contributed toward college costs each year. The actual amount can vary depending on the number of children in college and income levels.

Strategy #1: 529 College Savings Plan

A 529 plan is a tax-advantaged investment account specifically designed for education expenses.

• Contributions are not federally tax-deductible, but many states offer tax incentives.
• Investment growth is tax-deferred, and withdrawals are tax-free if used for qualified higher education expenses.
• No income restrictions.
• Parent-owned 529s are treated favorably for financial aid (assessed at up to 5.64%).
• Distributions are not reported as income on the FAFSA.
• Can change the beneficiary to another family member.
• Non-qualified withdrawals face income tax on earnings and a 10% penalty.

A Note on Retirement and Flexibility

Before considering 529s or any education-specific savings vehicles, many parents may want to prioritize retirement savings—and for good reason. First, having adequate retirement savings should be a priority over college planning. Second, Retirement accounts like 401(k)s and Roth IRAs are not counted as assets on the FAFSA, giving them favorable treatment for financial aid.

Both Roth IRAs and 401(k)s can be strategically tapped to help cover tuition, giving families optionality while maintaining long-term financial security. If you’re already contributing to a 529 but want to avoid overcommitting, consider directing excess savings to your 401(k) or Roth IRA. These accounts hedge future needs: if education costs run high, and your retirement income illustrations look favorable, you can draw on them—if not, they’re still there for retirement.

Strategy #2: Roth IRA

Though designed for retirement, Roth IRAs can double as a college savings tool.

• Contribution limits: $6,500/year ($7,500 if age 50+).
• Earnings grow tax-deferred.
• Contributions can be withdrawn at any time, tax- and penalty-free.
• Earnings can be used for qualified education expenses before age 59.5 without the 10% penalty, but will still be taxed as income.
• Income limits apply (phase-out starts at ~$218,000 for joint filers).
• IRAs are not counted as assets on FAFSA, but withdrawals count as income two years later.

Pro tip: Use Roth IRA funds after the student’s sophomore year FAFSA has been filed to avoid impacting financial aid.

Strategy #3: 401(k) Loans

Many employer retirement plans, including 401(k)s, allow participants to borrow up to 50% of their vested balance, up to $50,000.

• Loan proceeds are not reported as income or assets on FAFSA.
• Repayments are made with after-tax dollars and include interest (paid back to yourself).
• Must be repaid within 5 years, though terms may vary.
• Failure to repay converts the loan to a distribution, subject to taxes and penalties.

Advantages over Roth IRA withdrawals:

• 401(k) loans do not count as income for financial aid purposes.
• Both reduce future retirement savings, but 401(k) loans are not penalized in aid calculations the way IRA withdrawals are.

Best used in coordination with other savings, especially in later college years or when gaps in funding arise.

Other Accounts to Consider

Account Type	FAFSA Assessment	Pros	Cons
UGMA/UTMA Custodial	Student asset (20%)	Can be used for any purpose	High impact on aid, less flexible, belongs to child
Parent Brokerage	Parent asset (5.64%)	Unlimited investment options	No tax advantages, still impacts aid
Student-Owned Brokerage	Student asset (20%)	Potentially higher investment returns	High aid penalty, capital gains may count as income
Parent Savings/Checking	Parent asset (5.64%)	Liquid, easy to access	Low interest, no tax benefits

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📅 Timeline and Layering Strategies

Age Range	Recommended Actions
Birth to Age 5	Open 529 plan, begin contributions, utilize annual gifting from relatives
Ages 6–14	Continue 529, contribute to Roth IRA (if eligible), increase 401(k) savings
Ages 15–18	Run FAFSA simulations, avoid IRA/401k withdrawals, contribute to Roth after FAFSA filed
Ages 18+ (College)	Use 529 funds first, Roth IRA after sophomore FAFSA, 401(k) loan as needed for final years

Final Thoughts

College planning isn’t one-size-fits-all. Combining a 529 with a Roth IRA or a 401k with loan provisions provides flexibility and tax efficiency, while understanding FAFSA rules helps preserve eligibility for aid. For families with limited savings, a 401(k) loan can offer temporary relief—but it should be coordinated carefully.

Always consult a financial advisor to align these strategies with your broader retirement and financial goals.

For more Meeting RequestsIf you have questions, would like advice or would like to schedule a free retirement planning review please email Arcwood at: retirement@arcwood.com or to use our Calendly link click here.