You may be considering a college savings plan for your grandchild or child. There are pros and cons to each of these accounts, but a Roth IRA is a unique option.
I’m a huge fan of Roths, and I’ve written about how people over the income limits can fund an annual account via a “backdoor” contribution. Roths provide tax-free investment opportunities, tax-free withdrawals for those over 59.5 years of age, and virtually limitless growth. Roths are most often used in retirement. However, they have other positive features that make them a good option for your child’s future education.
The Benefits of Roth IRAs in College Savings
- Flexibility – The accounts mentioned in my opening paragraph were all designated for a beneficiary. A Roth IRA, however, is a retirement plan for you. A Roth is a viable option if your budget allows you to save for retirement over 529 contributions. If funding the education of your children is at the bottom your list of financial goals, or you think they’ll get a scholarship and not go to college or you don’t believe that will happen; Roth accounts give you flexibility. You can decide to use the money in the future.
- If you want to avoid penalties, then this is the way to go. The funds can be used for educational expenses such as tuition, room and board, and fees. Roth accounts have a unique tax situation whereby the owner of the Roth can withdraw contributions from the Roth account without penalty as long as it has been in existence for at least five years. You can still withdraw $50,000 if you have contributed $50,000 over the last ten years to a Roth IRA.
- When filling out FAFSA, parents must disclose financial aid, including 529s, custodial account, and non-retirement assets. Roth IRAs and retirement accounts will not be used in determining the EFC, making it easier for students to receive financial aid. A caveat is in order. The FAFSA counts withdrawals from retirement plans as income. Therefore, planning ahead is essential to ensure that your child receives the financial aid they need.
Drawbacks
- Limitations on contributions – You can only contribute up to $6,500 per year to an IRA if your age is under 50. If you’re over 50, you may make a contribution of $5,500. If you were to assume maximum funding over 18 years, then your Roth contributions would amount to $99,000. Your spouse’s contributions will be doubled if they also max out. These aren’t insignificant sums, but the contribution limit for education saving accounts is much higher. You are also restricted from contributing to Roths if your income is too high. Income phase-out for married couples is between $189,000-$199,000, and for singles or heads of households it’s between $120,000-$135,000. The backdoor method may work, but not for all.
- Retirement is harmed – College costs should never be paid at the cost of retirement or financial security. Roth IRAs are a valuable part of retirement planning. It is unwise to use them for a child’s education if you have other financial goals that need support. Other ways exist to finance college but there are few to secure a retirement.
- Taxation of earnings: As we have already mentioned, you are allowed to withdraw money from your Roth account without any penalty as long as the funds are being used for educational expenses. If you’re under the age of 59.5 then any gains or appreciation that is withdrawn will be taxed as income. It is not ideal, as 529 account earnings can be used to pay for education costs tax-free. Roths are viable for those who have grandchildren or children in later life.
This post is not advocating that you should only use a Roth IRA for saving money to pay for the education of your child. A 529 plan, or even a brokerage will work best in most situations. Roth IRAs can be a part of your educational savings plan if you have the correct personal facts.
