Saving for niece's education: Roth vs 529 vs something else?

I am considering starting an account to help fund my girlfriend’s niece’s education. I am looking at contributing a small amount each month. I would also like to maintain control of the money and be able to withdraw it (for my own use) in case of emergency, or in case she doesn’t need the money or decides not to go to college.

The purpose of this question is to compare using a 529 vs a Roth IRA as this savings vehicle, although I am open to other vehicles as well. Note that the Roth would NOT be considered retirement savings, I have a 401k as well.

One advantage of not using a 529 is that if the niece goes to a private high school, I couldn’t use 529 money for it, but I could use Roth money.

One advantage of a 529 is that I can use all of it (including earnings) for qualified expenses tax-free, but if I wanted to withdraw earnings from the Roth I would have to pay a penalty (right)?

Assuming two endgames:

1) Niece goes to college and uses all the money
2) Niece doesn’t go to college, or I need the money myself

What are the advantages and disadvantages of a 529 vs a Roth vs (any other option that I may not be considering)? And which one might you recommend?

Thanks!

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3 Responses to “Saving for niece's education: Roth vs 529 vs something else?”

  1. A 529 plan is set up in a specific beneficiary’s name but the money can be rolled over or transferred into another 529 plan in the same beneficiary’s name, or the beneficiary can be changed by the owner of the account. I mistakenly believed that the new beneficiary could be anyone else, but as mhoran_psprep has
    pointed out in the comment below, the new beneficiary must be related to
    the previous one in specific ways as detailed in
    Publication 970 2011, Tax Benefits for Education in order for the change to occur
    without any tax consequences. So my original statement that distributions can be used for anyone’s educational expense without tax consequences was incorrect; if the new beneficiary is not related to the original beneficiary, tax consequences will indeed occur. Note also that unlike IRAs where the entire
    amount can be withdrawn by the owner without incurring a 10% penalty after
    a certain period or after reaching a certain age, distributions from a 529 plan
    for nonqualified expenses (including as a special case
    a withdrawal of funds by the owner)
    will incur the 10% penalty tax regardless of when this occurs.

    The problem with UGMA accounts is that you have to turn the money over to the beneficiary when that beneficiary becomes an adult (18 years old in most cases) regardless of your current opinion of that beneficiary, and the beneficiary is free to use the money to buy a motorcycle with it if she chooses instead of using it for her education. In this sense, I agree with mhoran_psprep’s answer that it is best to put away the money in an ordinary account without seeking tax benefits, and deal with the matter as you see fit when the niece is filling out her college paperwork.

  2. The biggest issue is determining how committed you are to this “niece”. When setting up an account (529/prepaid tuition/Universal Gift to Minors/Coverdell/Roth) you are making a commitment that locks you into some provisions. They all have different amounts of control, and can impact taxes and financial aid.

    The states involved can even be important. Some will give tax breaks. How they handle state vs private schools and out of state schools will also differ.

    The problem is that it is hard enough knowing what a kid 10-18 years from now is going to want to do, or be able to do. The government has crafted some provisions to handle these complex issues: scholarships, going to a service academy, going to a private school, death of the child…what I don’t think they have covered is ending the relationship.

    The best option is to set aside the money in a regular account, with no special tax provisions; and then when they are close to graduating determine the best way to handle the transfer. Yes you may have given up some tax benefits, but it will still be your money.

    You will have to determine how this money will be transferred, but that will depend on the tax rules, and financial aid policies in the future. Options include gift to niece, direct payment, graduation gift…

  3. I know it isn’t exactly the question you asked, but please consider your future too.

    529 is the correct answer, because if you can fund a Roth, you should be funding it for your own retirement.

    Your retirement has much a higher priority over anybody’s college fund. It is pretty great that you want to set aside cash for the niece’s education, I think asking which vehicle is best for saving for education might be the wrong question.

    Students have many options for going to school and paying for it but retirement is pretty limited.

    http://www.clarkhoward.com/news/clark-howard/education/clarks-529-guide/nFZS/ is a good place to learn about 529s and makes good suggestions on where to get one. Do it yourself, and don’t pay a broker or agent to do it for you.

    If your retirement is already handled, feel free to vote me down and I will delete this.