Benefits of Roth IRAs for College Savings
With the “Back to School” season upon us, it might be a good time to start thinking about how you are going to pay for that higher education. Whether it’s for yourself, a child or grandchild, a Roth IRA may just be the solution.
Most people think of an Individual Retirement Account, or IRA, as a way to save for retirement but, it can also be a great tool to help cover college expenses. Unlike some other options, which can only be used to cover the costs associated with higher education, a Roth IRA can be used for both college expenses and retirement income. This means any money not spent on education can be still be saved and used for retirement.
An IRA is a personal retirement program established by the Internal Revenue Service to encourage individuals to save money for their retirement. IRAs feature many incentives such as tax-deferred or tax-free earnings, and in some cases tax deductibility.
As of January 2, 1998, customers have a choice between establishing a Traditional or a Roth IRA plan. One of the benefits of going with the Roth IRA is the penalty-free withdrawals for higher education.
In most cases, any withdrawals from an IRA before the age of 59 ½ are subject to both taxes and an IRS penalty. But there are some exceptions to this rule with a Roth IRA and college is one of them.
There is no 10% penalty for withdrawals from a Roth IRA for qualified higher education expenses for you, your spouse, your child or your grandchild. You would still have to pay taxes on the earnings.
A person needs to have “earned” income to contribute to a Roth IRA, and there are strict contribution limits. Money in a Roth IRA is not counted as an available asset for financial aid purposes, which will decrease your Expected Family Contribution on the FAFSA application and increase your odds of receiving financial aid. The drawback, if money is withdrawn from the Roth IRA, whether for college or other reasons, the full amount will be counted as income on future applications.
Roth IRAs don’t have age restrictions, but they do have income-eligibility restrictions: In 2018, single tax filers, for instance, must have modified adjusted gross income of less than $135,000 to contribute to a Roth IRA. Married couples filing jointly must have modified AGIs of less than $199,000 to contribute to a Roth IRA.
Another option that is available for saving for college would be a 529 Plan. This is a tax-advantaged savings plan designed to encourage saving for future education costs, which is sponsored by the state. This is usually a good way to save for schooling since you can use up to $10,000.00 of your 529 money per year for K – 12 private school tuition. Another benefit of the 529 Plan is that you might be able to deduct some or all of your contributions for state income tax purposes.
Why would someone consider using a Roth IRA instead of a 529 Plan? The biggest reason is flexibility. You can save money now and later on decide to use the money for college or keep the money for your retirement and pay for college another way. A 529 Plan doesn’t have as much flexibility. If the money is withdrawn for any other reason than qualifying education expenses, you not only have to pay taxes on the earnings but are also hit with a 10% penalty. So if you aren’t fully committed to a college education but want to prepare, the Roth IRA may be your better choice.
Consult your tax or investment advisor on your best options for saving for college education and preparing for your future retirement.