Can You Save for College with a Roth IRA?

The cost of college is no joke. We’re talking about tuition, textbooks that go for upwards of $350, and decking out a dorm room. With college expenses accumulating faster than ever, clients have been asking, “Can you save for college with a Roth IRA? Should you?”

So what’s the best option for saving for your child’s college? You could use a 529 plan, which is a savings plan intended for schooling. Or you can save for college with a Roth IRA—yes, it’s technically a retirement account, but it can serve other purposes, too.

529 plans and Roth IRAs both offer tax benefits, and each has its pros and cons. Let’s take a look at how using a Roth IRA could help you save for your child’s college.

The Basics of a Roth IRA

If you want to save for college with a Roth IRA, you should know the ABC’s of how this type of account works.

A Roth IRA is a type of retirement account that allows you to pay taxes on contributions now so that you don’t have to pay taxes when you withdraw money down the road. You can contribute up to $6,000 per year to a Roth IRA, or up to $7,000 if you’re age 50 or older. (Finally, an advantage of growing older!)

There are income limits for anyone saving with a Roth IRA, though. If you’re single or file taxes separately from your spouse, your modified aggregate gross income (MAGI) must be below $122,000 per year for you to max out your contributions. What if you want to contribute money but not necessarily max out? Then your MAGI should be below $137,000.

Are you married and filing taxes jointly? Then your household MAGI should be under $193,000 to max out contributions and under $203,000 to contribute partially.

Can You Save for College with a Roth IRA?

You may use your Roth IRA savings to fund a round-the-world trip or finally build your beloved vinyl record collection. But using that money to fund your child’s education is just as valid of an option. In fact, there are actually a couple of benefits to paying with a Roth IRA.

You may already know that the IRS can penalize you for making an early withdrawal from a Roth IRA. Typically, if you withdraw contributions before age 59 ½ or before the account has been open for five years, you have to pay a 10% early withdrawal penalty.

The good news? If you withdraw early for qualified education expenses, like your child’s college, that 10% penalty is waived. You’ve got to love a loophole!

You might also be aware that the amount of financial aid your child receives depends on your annual income. The more you earn, the less they’re eligible to receive in aid. So you might be wondering, “Is money from my Roth IRA actually going to hurt my child financially?”

More good news: The amount you withdraw from a Roth IRA doesn’t factor into your expected family contribution for the year, so it won’t diminish your child’s financial aid… at least not immediately.

The bad news? Because of the way taxes and the Free Application for Federal Student Aid (FAFSA®) work, your Roth IRA withdrawal will show up in your expected family contribution two years after you take it out, which could mean less financial aid in two years.

But don’t worry, there’s another loophole! If you can wait until your child has filled out the FAFSA for their second year of college or later, the withdrawal shouldn’t affect financial aid.

Yes, you can (and maybe even should) save for college with a Roth IRA. But as with any big financial decision, there’s a trade-off.

When you withdraw money from your retirement account to pay for their education, you are saving less for retirement as a result. Not only could this mean no round-the-world voyage or vinyl record collection, but it could actually make it hard to live comfortably after retirement.

If you feel confident that you can still save a hefty sum for retirement, paying for college with a Roth IRA might be the best decision. If you’re worried that you won’t have enough saved for retirement, a 529 plan is probably the better fit.

The Importance of Basis

It’s crucial to keep track of your Roth IRA basis, which is the money in your account that has already been taxed. Remember, when you contribute to a Roth IRA, that money is taxed before it goes in, but gains aren’t taxed until you withdraw them.

Why does basis matter when you save for college with a Roth IRA? Well, you don’t have to pay the 10% early withdrawal tax on contributions if they’re being used for qualified education expenses. But if you make an early withdrawal of money you’ve earned from investments (which hasn’t been taxed yet), you will have to pay income tax on those earnings.

Let’s say you’ve contributed $18,000, then earned $5,000 from investments. You have $23,000 total in your Roth IRA, and $18,000 is the basis.

When you withdraw that $18,000, you won’t pay any income tax. But once you go over $18,000 and dip into your earnings, you’ll pay income tax on everything over the $18,000 mark. Keep this in mind when withdrawing money to pay for college—you don’t want any surprises!

Granted, you only have to pay income tax on earnings if you’re under 59 ½ or haven’t had your Roth IRA for five years. If you meet both of those criteria, you won’t have to pay income tax on earnings. Did you have children later in life, so you’ll be at least 59 ½ when they go off to school? Or are you a grandparent wanting to contribute to a grandchild’s education? Then saving for college with a Roth IRA really could be the dream scenario.

What do you think—do you want to save for your student’s education with a Roth IRA? Weighing the pros and cons can help you come to a decision, but if you want more guidance, a professional can break down the entire process with you.

We’re always ready to talk about planning for your future. Feel free to reach out and book a free introductory meeting today!

investing for retirement ebook ipad - McClain Lovejoy
investing for retirement ebook ipad - McClain Lovejoy
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