Choose Wisely With College-Savings Vehicles

Karen Wallace: I'm Karen Wallace for Morningstar.com.

College savers are investing with a critical goal and a fixed time frame. Given the high financial and emotional stakes involved in choosing and paying for college, investors should feel confident about their choice of savings vehicle, whether it's a 529 plan, a Coverdell, or a Roth IRA.

There are many different college-saving options to choose from, which differ in terms of their tax treatment and investment flexibility, as well as their effect on financial aid eligibility. 529 savings plans have become popular choices because they allow you to save a significant amount of money and they have money-saving tax advantages, including state tax breaks on contributions and tax-free compounding and withdrawals for qualified higher-education expenses.

Coverdell and Roth IRAs allow investors more freedom to select investments than 529 plans, but their yearly contribution limits are smaller and investors above certain income limits are not eligible to contribute.

Finally, it's important to understand how different college-savings vehicles impact a student's financial-aid eligibility. Assets in a 529 plan and a Coverdell plan have minimal impact on a student’s financial aid eligibility, as long as the accounts are owned by the parents or dependent student. Roth IRA or other retirement account assets could have no impact or a large impact: They aren't counted in the financial aid eligibility calculation at all, unless a distribution is taken to pay for college. After that, those assets used are counted as income and will have a larger impact on the student's financial aid eligibility.

Thanks for watching. I’m Karen Wallace for Morningstar.com.