Can I Use a Roth IRA to Pay for College?

Which is better a public or private college?

Whether you have children or grandchildren that are looking to receive a college education in the future, you’ll be considering the ways in which you can effectively and efficiently put money aside to help them pay for college. There are several ways that you can do this, including utilizing your Roth IRA or setting up a 529 college savings plan.

What is a Roth IRA?

Before discussing the effectiveness of using a Roth IRA as a means to pay for college, it’s important to first identify exactly what it is. For those that aren’t familiar with this term, a Roth IRA is a type of retirement account that’s tax-free. 

Any withdrawals made from it when you hit retirement age are also tax-free. If you’re over 59 and have had the account for over 5 years, you’ll be able to take distributions from the account that count as your earnings.

What is a 529 College Savings Plan?

Another plan that people look into when deciding how they will fund their children’s college degree is a 529 college savings plan. This type of savings plan is very advantageous when it comes to tax and has been created to encourage saving for future education requirements.

 A qualified tuition plan, it’s directly sponsored by different states, educational institutions, or state agencies that have been authorized by Section 529 of the Internal Revenue Code. Typically, there are two types of 529 college savings plans available – education savings plans and prepaid tuition plans

Can I Utilize a Roth IRA to Cover College Expenses?

Many people wonder whether they can use their Roth IRA for college savings instead of having to open a 529 college savings account. And although you can indeed use it to cover the expenses that come with college, it’s arguably better used as a way of saving for your retirement.

Why? Because retirement is a time in the future that’s very uncertain. Not only do you not know what the future holds in terms of your health, but also your overall finances – which is why it’s worth saving as much as you can in a Roth IRA to mitigate any possible risks.

But before you make your final decision on how to effectively save money for the college fund, it’s good to look at the two options in more detail. 

529 College Savings Plans vs. Roth IRAs – Tax

Comparing The Tax Benefits

When looking at the big picture, you’ll discover that both options offer tax-free growth and are directly funded with after-tax dollars. However, when comparing the two, you should enquire whether your state will offer any favorable tax benefits if you contributed to a 529 college savings plan

However, when looking at the Roth IRA, you’ll see that you’re allowed more freedom in terms of what you can invest in it and the tax benefits that come with it. The 529 college savings plan, however, is limited to a small selection of choices, giving you less flexibility.  

Roth IRA – How The Withdrawals Are Taxed

As aforementioned, you’ll only be able to benefit from tax-free withdrawals if you’re over 59 and have held the account for over 5 years. If you withdraw earnings before then, you’ll have to pay a 10% withdrawal penalty for doing it early and face an ordinary income tax rate.

A way of avoiding this penalty is if the education expenses are qualified. Keep in mind, however, that the income tax will have to be paid on the amount that you’ve taken out regardless.

It’s also important to recognize that the Roth IRA is made up of both earnings and contributions. So if you want to withdraw the contributions before this age, you can do so without having to pay the penalty or tax.

529 College Savings Plans – How The Withdrawals Are Taxed

If the earnings and contributions are used for qualified education expenses, you won’t have to pay taxes or penalties. This is a huge benefit that showcases why many people opt to use 529 college savings plans instead of a Roth IRA to fund a college education.

However, if the education expenses are not qualified, you’ll have to pay a 10% penalty and income tax on the earnings that you’ve withdrawn. It’s vital to know that 529 college savings account distributions are done pro-rate, therefore you won’t be able to withdraw contributions on their own unless in the case when the account has no earnings within it.

529 College Savings Planss vs. Roth IRAs – Contributions 

The amount that you can contribute will also play a large part in which one you decide to go for. 

  • Roth IRA – the maximum contribution that you can make yearly to a Roth IRA is $6,000 or $7,000 if you’re over the age of 50.

Terms and conditions 

You will only be able to contribute $6,000 if:

  •  Your gross income when modified and adjusted is less than $122,000 (for single filers). 
  • If married and you’re filing jointly with a household income that’s less than $193,000, or a partial contribution if it’s up to $203,000.

Alternatively, a Traditional IRA can be converted in the case of a backdoor conversion. This applies directly to savers on any income level, making this option more accessible.

  • 529 College Savings Plan – gives you the freedom to contribute up to $15,000 per year for each 529 college savings account you hold. This won’t incur federal gift tax.
  • Up to $75,000 (for single contributors) or $150,000 (for married contributors) if it’s over 5 calendar years for tax purposes.

Terms and conditions 

Yet again another plus point for 529 college savings plans is that there are no income limits for those wishing to contribute to them – making it more flexible for those on both low and high incomes.

529s vs. Roth IRAs – Financial Aid

Roth IRA

You might be wondering, do Roth IRA assets affect financial aid in any way. Well, similarly to Traditional IRAs or 401(ks), the more your family contributes to the Roth IRA, the less financial aid. Your expected family contribution will be calculated using an application found within the Federal Student Aid website

However, the familiarity between retirement accounts doesn’t end there. If you want to use the money within the Roth IRA to pay for college, it will have an effect on your expected family contribution for at least two years afterward. This is due to the fact that when the withdrawal appears as income on the FAFSA form, it will be at a 20-50% rate.

Of course, you can help to minimize the impact of this by filling out a FAFSA when your child is going into their second year of college and by not using the Roth IRA distribution until then.

529 Colledge Savings Plans

When determining the eligibility of financial aid, the 529 college savings account assets are counted at a 5.64% rate. Any qualified distributors aren’t counted as income, meaning that there is no effect on expected family contribution. 

However, if the 529 college savings account isn’t owned by either a parent or a student, perhaps their grandparents, there is a pitfall when it comes to financial aid. On the FAFSA form, any distributions made will be counted as untaxed income, at the same rate as a Roth IRA. 

To minimize this, you could use the same trick as above – filling out a FAFSA when your child is going into their second year of college and by not using the 529 college savings account distribution until then.

Overall, it’s clear that if you’re saving money for college, it’s vital that you first consider both options and compare and contrast the benefits of each. From the above information, it’s fair to argue that to safeguard your retirement savings, 529 college savings accounts might be the better option. 

Although they are not perfect, they are deemed to be a better fit and more suitable for dedicated college savings. Offering low-cost investments and flexibility when it comes to financial aid, it’s easy to see why so many people opt for this choice overusing a Roth IRA.

using a Roth IRA for college

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