Most parents dream of giving their children a better future, often by creating a financial safety net to cover future costs like college, a car, rent and other such expenses.
However, for those parents trying to build a portfolio that would later go to their children, navigating the investment world can be scary, especially when faced with two very different options, like a 529 College Savings Plan and a Roth IRA.
Because the 529 fund grants certain tax advantages for education and the Roth IRA offers flexibility for expenses not related to college, parents are often torn between the two options. The choice often hinges on counteracting probable tax penalties, the likelihood of the child attending college and flexibility in the long run.
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One such investor, a devoted Alabama father, recently shared his dilemma on Reddit, an online forum with over 2.6 million members. With $500 available and a monthly contribution plan of $50 to $100, he wants to provide a better start for his 1-year-old daughter.
“I wanted to put this into an investment plan like a Roth IRA or a 529 fund, but I’m not sure the best route to go. 529 sounds like the best option, but I’m afraid she may grow up and not go to college and then the money would have to be taxed and all that jazz,” the father wrote.
He isn’t sure if his location influences his decision, so he is asking Redditors for advice on the best way to increase his humble savings.
Let’s review the recommendations other investors in Reddit’s r/investing community have given the Alabama dad.
529 Plans are the Best Fit Due to Tax Advantages and Flexibility
Many Reddit members highlighted in the comments that the 529 offers amazing tax benefits and can be tax-free if used for qualified educational purposes.
“The growth is definitely going to be taxed in a regular account (she doesn’t qualify for a Roth IRA) and only maybe in the 529,” a comment reads.
Unlike a standard investment account, where growth is taxed, a 529 plan allows you to avoid tax altogether and Redditors made sure to emphasize this advantage.
“You’re guaranteed to pay taxes with any other route. You may not pay taxes with the 529,” a Redditor says.
According to one comment, if the daughter won’t use the money for educational purposes, up to $32K can be transferred to a Roth IRA or other family members.
“I would recommend the 529 for you. If your kid doesn’t end up needing the money, up to $32K can be rolled over into their IRA (after you’ve had the 529 for five years). But you also can use that money for their family members, like siblings or children/spouse or even parents (yourself),” the Redditor’s comment says.
While the returns will be taxed and the account owner must pay a 10% penalty if the funds aren’t used for college, Redditors still believe the 529 plan is better than a Roth IRA.
“And at the end of the day, if it’s not used for education or the IRA, yes, you’d pay taxes on the gains and a 10% penalty, but with enough time in the market, you’d still have a good outcome,” a Reddit member wrote.
Involve the Child in the Investment Journey
One unique recommendation focused on using the investment process as a financial educational tool for the child. According to one Redditor, involving the daughter in this journey as she grows can help her develop healthy financial habits.
“Don’t overlook the impact you can have by involving your daughter in this in the future. Of course, you must decide for her now, but once she is older, you can show her how small regular contributions have grown and let her be part of the journey – the hope is that it instills in her an understanding of saving and a commitment to it,” the Reddit member suggested.
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