Roth IRA for college / IRA for child

Understanding Roth IRA’s for College

The cost of college has increased significantly over the last few decades. It is becoming more important for parents to save money for their children so that their kids do not graduate with a ridiculous amount of student loans. Many parents start saving once their child is born so that they have enough time to contribute and fewer loans to take out. There are so many ways to save for college now; loans should be a last resort. Although saving for college is beneficial, saving for your retirement is generally considered to be more important. A Roth IRA is a great option when you want to do both, save for retirement and for college.

How It Works

An IRA is an individual retirement account. Parents can pay for college expenses by withdrawing money from their IRA without a penalty. You can use this money to pay for tuition, fees, books, room and board, and other supplies. This is useful when you didn’t plan ahead and need to use retirement savings to pay for college.

When you withdraw from your Roth IRA it is considered a “return of contribution” first and earnings second. This allows people who have leftover funds after withdrawing for expenses to have that money become retirement income, and you don’t have any tax consequences or penalties. Your contribution is not deductible with Roth IRAs, but it does grow tax-free, so your money grows faster than a regular savings account. Once you turn 59 and a half, all of your withdrawals, earnings, and contributions are tax-free.

Advantages

A Roth IRA is very flexible, so you can keep money in your account as long as you would like. After the age of 59.5, you can withdraw money without paying taxes if the account has been open for at least five years. Fortunately, there are no mandatory withdrawals like there are with Traditional IRAs where you have to withdraw starting at age 70.5. You can continue to save during retirement with a Roth IRA.

Disadvantages

There are a few downsides to using a Roth IRA to pay for college. First, the distributions count as untaxed income on FAFSA ®, which can lower the eligibility for need-based financial aid. This is because income has a greater impact on a student’s eligibility than assets. Another disadvantage is that there are contribution limits, which is $5,500 unless you are over the age of 50, then it is $6,500. People with high incomes cannot use a Roth IRA to pay for college. As of 2016, individuals can only contribute if they make less than $116,000 and married couples if they make less than $183,000. It’s important though to make sure you have an income to contribute to your IRA, otherwise, you cannot use it for college expenses.

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How College Impacts Your IRA Growth

A huge benefit to Roth IRAs compared to other savings accounts is that you can use it for retirement and college savings. When a family withdraws from their Roth IRA account, the money is tax- and penalty-free only if it is used for educational expenses. Any money that is not used for school can be used for retirement without paying a penalty. One person can have multiple Roth IRA accounts, even though the amount you can contribute each year is the same. If you want to save money for retirement only, I recommend setting up a Roth IRA account that you don’t use for college expenses or use a Traditional IRA account. If you want money only for college, that you know will all go towards college, you can use a 529 plan.

What Families Should Consider

It’s important to weigh the pros and cons of using a Roth IRA. In today’s world, there are many financial priorities and it can be overwhelming. Roth IRAs can give you peace of mind because you are saving for college expenses as well as your retirement. Make sure you evaluate all of your options and do what is best for you and your family. Consider how you want to spend the money you contribute to your account and what options you want to have when it comes to paying for college and saving for retirement.