Should I use my Roth IRA for college?
As a former financial planner, I would often get these questions from clients who read something somewhere. Much like patients asking doctors about drugs they heard about on TV, such questions rarely ended up being a good idea. Still, it is possible to use a Roth IRA to pay for college, but it only makes sense in very specific circumstances.
First, you probably know that a Roth IRA is designed for retirement savings, so that is what it is best used for. The corresponding vehicle for parents saving for college is a 529 college savings plan. In general, the best way to save for college is in a 529 plan versus a Roth IRA. That being said, a Roth IRA can be used, and may be clever in certain circumstances.
Can I Use Roth IRA for College
Let’s start with CAN you use a Roth IRA to pay for college. We’ll look at SHOULD you use a Roth IRA for college next.
As you may know, a Roth IRA offers tax-advantaged growth for investments within the account. This creates two kinds of money inside of a Roth IRA. The first kind of money is contributions. Contributions are the monies directly deposited into the account. They do not include any dividends, interest or gains on investments. If you put $5,000 in a Roth IRA for 10 years, then your contributions are $50,000, no matter what the account is actually worth. Any amount above $50,000 is earnings.
There are two features of a Roth IRA that allow for its use to fund college without paying penalties. First, all contributions can be withdrawn without penalty or taxes. In other words, in the case above, the taxpayer could use $50,000 to pay for college (or anything else for that matter) without taxes or penalties.
The second feature is that there is an exception allowing Roth IRA funds to be used to pay for qualified college expenses. Basically, if you are deliberately trying to stretch what “college expenses” means, it probably counts. Tuition, fees, books, supplies and equipment, at an institution with the word university or community college in the name are pretty much all covered. (Typically, non-degree programs like a coding bootcamp, or writers retreat don’t count.) You are allowed to pay such expenses for yourself, your spouse, your children, and their descendants (that means grandkids and great-grandkids are included).
However, this Roth IRA distribution exception only applies to the penalties that would ordinarily be due. The withdrawal does still count as taxable income. This can be a double whammy, because not only do you owe taxes on these funds, but it also increases your income for purposes of financial aid. Since financial aid takes into account your income, artificially inflating it by taking funds from your Roth IRA may not be a good strategy.
Is It Smart To Use Roth IRA for College?
Additionally, you are literally stealing from your retirement in order to pay for a child’s college. Not only is that money not available for your retirement, but that money is not able to grow while you are still working. At 8% growth over 20 years, that $50,000 withdrawal isn’t just $50,000 gone from your retirement, but $234,500 gone from your retirement.
One of the running themes on this blog is that despite what might be “best” mathematically isn’t necessarily what is right for each of us as unique humans with emotions. For parents who really want to help their kids with college, but who don’t have any other money saved up, a Roth IRA offers a tempting, if non-optimal, way to tap into some funds. That being said, keep it as minimal as possible, ideally, no more than the total amount of your contributions to avoid additional taxes.
Remember, as unappealing as student loans sound, there is no such thing as retirement loans. Consider if you are better off helping your child pay back students loans over time, rather than raiding your retirement savings to send them to college.
If you, or your child, is already looking to pay for school, the Roth IRA is an option, if not the best one. If, however, you are thinking of how, or where to save, consider setting up a 529 plan instead and save money specifically for college.