When it comes to saving for college, most people think of 529 plans. But there’s another option that offers more flexibility: the Roth IRA. While traditionally used for retirement savings, using a Roth IRA for college can also be a smart way to fund education expenses.
In this article, we'll explore the basics, the tax benefits, and how a Roth IRA works specifically for college costs.
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What is a Roth IRA?
A Roth IRA is an individual retirement account (IRA) that allows your investments to grow tax-free. Unlike traditional IRAs, contributions to a Roth IRA are made with after-tax dollars, meaning you won’t get an immediate tax break.
However, the real advantage comes later: When you withdraw funds in retirement, the money—including any investment gains—is yours out tax-free, provided you follow the rules.
“At its core, a Roth is meant to supplement traditional retirement accounts,” says Steven Kibbel, a financial planner and Chief Editorial Advisor at Gold IRA Companies. “You're able to stash away up to $6,500 annually—$7,500 if you're over 50—and not pay taxes on gains down the road.”
The main tax benefits of a Roth IRA are:
- Tax-free growth: Since contributions are made with post-tax dollars, your investments grow without being taxed. This can significantly increase your savings over time.
- Tax-free withdrawals in retirement: Once you hit age 59½ and the account has been open for five years, withdrawals are entirely tax-free.
- No required minimum distributions (RMDs): Unlike traditional IRAs, Roth IRAs don’t require you to start taking withdrawals at a certain age, offering more flexibility in how you use the funds.
Can a Roth IRA be used for college?
Yes, a Roth IRA can be used for qualified college expenses. The IRS allows withdrawals for higher education expenses, such as tuition, fees, books, and supplies.
“You have the option to use your own Roth IRA contributions for approved school costs anytime with no penalties,” Kibbel says.
Roth IRA for college savings: How it works
The next time someone asks you, “Can you use a Roth IRA for college expenses?” you can confidently tell them yes. Roth IRA funds can be used to cover qualified education expenses, including tuition, books, and room and board (if the student is enrolled at least half-time).
But it’s important to weigh the impact that using a Roth IRA for college might have on both your retirement savings and potential tax implications.
You can withdraw contributions without penalties at any time, but withdrawals of earnings before age 59½ may be subject to both taxes and a 10% penalty unless they meet specific exceptions. However, if the funds are used for qualified education expenses they won’t incur the penalty on the earnings.
“Funds in any type of IRA are typically held for use in retirement, but in some circumstances can be used to cover qualified higher education costs without incurring a 10% early distribution penalty,” says Georgia Lord, Head of Financial Planning at Corbett Road Wealth Management.
“Your contributions can be used to cover higher education expenses without tax or penalty.”
However, you’ll still need to pay income tax on the withdrawn earnings. Additionally, this usage might impact financial aid calculations, as withdrawals count as income.
So, can you withdraw from a Roth IRA for college expenses without penalties? While there's no penalty for early earnings withdrawals for college, income tax will still apply.
Pros of using a Roth IRA for college savings
- Flexibility: If you don’t end up needing the money for education, you can still use it for retirement.
- No penalties on contributions: You can withdraw your contributions at any time without penalties, offering liquidity in case of emergency.
- Tax-free growth: Investments grow tax-free, potentially yielding higher returns over time.
- Can be used for other purposes: Unlike 529 plans, which are strictly for education, Roth IRAs can be used for other major expenses if college costs are lower than anticipated.
Cons of using a Roth IRA for college savings
- Impact on financial aid: Roth IRA withdrawals for college expenses are considered income and may reduce the amount of financial aid your child qualifies for.
- Limited contributions: The contribution limit for 2024 is $6,500 ($7,500 for those 50 or older), which may not be enough to cover significant education expenses.
- Tax on earnings: While you can avoid penalties, you’ll still owe income taxes on any withdrawn earnings used for college.
- Potential retirement shortfall: Using a Roth IRA for college might reduce your retirement savings, which could be challenging to replenish later.
“For college expenses, a Roth IRA can serve as a flexible savings tool, especially for those who may not qualify for other tax-advantaged educational savings accounts, like 529 plans,” says Josh Katz, Certified Public Accountant (CPA) and founder of Universal Tax Professionals.
“Just keep in mind that using a Roth IRA for college can reduce the balance available for retirement, so this option should be weighed carefully based on your long-term goals.”
Roth IRA vs 529 Plan
While both Roth IRAs and 529 plans offer tax advantages, they have distinct differences when it comes to saving for college.
A 529 Plan is a tax-advantaged savings plan designed to help families save for education expenses. There are two main types of 529 Plans: the 529 College Savings Plan and the 529 Prepaid Tuition Plan, which focuses on locking in tuition costs at today’s rates and typically has a more limited scope.
Here's a comparative table highlighting the key differences between a 529 Plan and a Roth IRA:
Purpose
- 529 Plan: Exclusively for education expenses
- Roth IRA: Primarily for retirement (although yes, it can be used for education expenses)
Tax benefits
- 529 Plan: Contributions grow tax-free; withdrawals for qualified education expenses are also tax-free
- Roth IRA: Tax-free growth and withdrawals in retirement; some flexibility for college expenses
Contributions
- 529 Plan: Much higher than Roth IRAs; often up to hundreds of thousands depending on the state
- Roth IRA: Lower; limited to $6,500 annually ($7,500 if 50 or older)
Financial aid impact
- 529 Plan: Considered a parent asset; minimal impact on financial aid
- Roth IRA: Withdrawals count as income; can reduce financial aid eligibility
“A pro to relying on money in a Roth IRA for college expenses is that it is not counted when determining one's eligibility for financial aid, where 529 Plan assets are,” Lord says. “Money in both a Roth IRA and a 529 Plan can be applied toward post-secondary tuition, but a 529 Plan can also fund K-12 tuition and be applied to student loans up to certain limits.”
Balancing the use of a Roth IRA with a 529 plan could provide a well-rounded savings strategy for both college and retirement.
FAQs
Can a Roth IRA be used for room and board?
Yes, but only if the student is enrolled at least half-time, and the expenses are considered qualified under IRS rules.
What are the penalties for withdrawing from a Roth IRA for non-qualified expenses?
If the Roth IRA for college withdrawal is not for a qualified education expense or another IRS exception, you may face a 10% penalty on the earnings and income tax on the amount withdrawn.
What if I don’t use the Roth IRA for college?
No problem. The funds can continue to grow tax-free and be used for your retirement.
Which is better: Roth IRA or 529 for college?
It depends on your goals. A 529 plan offers more advantages for education savings, but a Roth IRA provides greater flexibility if college isn’t the only financial priority.