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Should I Use a Roth IRA to Pay for College?

Should I Use a Roth IRA to Pay for College?

Families spent an average of $30,017 on college during the 2019-2020 academic year, according to the Sallie Mae report How America Pays for College.

More than one-third of families used a college savings account such as a 529, which is up from 21% in 2018-2019.

If you look closer at the report, you'll also see a list of other ways parents and students pay for college. A retirement savings withdrawal (including 401k, Roth IRA or another type of IRA) made up 2% of sources parents used to pay for college.

Should you tap into your retirement savings to pay for college for your child? Let's dig in.

What is a Roth IRA?

Roth IRAs, a tax-advantaged retirement vehicle, allows you to grow your money tax-free with tax-free withdrawals after age 59 ½. You may only contribute $6,000 in 2021 (you can contribute $7,000 if your age clocks in at 50 or older). Your modified adjusted gross income must not go over $140,000 (for single filers) or $208,000 (for those married filing jointly). 

You will have already paid taxes on the money you put in the account. You pay taxes on money you put in the account. You cannot deduct the contributions on your taxes. As long as you've had your account for five years and you've hit the required age limit, you can take distributions and earnings without paying federal taxes. A Roth IRA does not require you to take money out of your account, also called required minimum distributions (RMDs). In other words, you can keep the money in your Roth IRA until you turn 103 if you want to.

Why Use Your Roth IRA to Pay for College?

You may feel hesitant to use your Roth IRA to pay for your child's college education, and that's a really healthy pause. After all, you can't borrow for retirement, but your child can borrow for college if necessary. 

You can only use your Roth IRA to pay for college if you plan to:

  • Use the money for education for yourself, a spouse, child or grandchild.
  • Pay for qualified educational expenses (tuition, fees, room and board, books, etc.). Qualified expenses don't include things not needed for college, such as a new car to get to and from classes. 
  • Use the money to pay for school as long as the institution can prove accreditation. This can include a public, nonprofit or private institution, a for-profit college, university, or a vocational school.

The attraction to using a Roth IRA to pay for college: Before you turn 59½, you typically must pay a 10% penalty if you withdraw money from your Roth at that age. However, you can become exempt if you use it for higher education. Amounts withdrawn should come from your original Roth IRA contributions. If your money comes from your original Roth IRA contributions, but it has been more than five years since you contributed or converted money into a Roth IRA. Note: You will still pay income tax on the earnings portion of the money in your Roth IRA.

How to Use a Roth IRA to Pay for College

Take these steps if you think you might tap into your Roth IRA to pay for college.

Step 1: Assess how much you need to pay for college.

How much does your child need after scholarships, regular contributions from your monthly income, your students' monthly income and other sources? Determine how much you need to pay for college, then multiply that by four — and then some. Often, scholarships don't last. Merit scholarships don't make up the difference between rising tuition. Furthermore, many students take longer than four years to get through school. You may want to consider how much this figure could bloom ahead of time. Also consider how much your other children's college expenditures could cost if you have other kids.

Step 2: Consider your future needs.

How much have you saved for retirement, and what will you pull together as retirement savings? Some financial experts liken retirement savings to a big puzzle. You may pull from Social Security, your retirement savings and other savings methods to save for retirement. Consider all these other options for pulling together money for retirement: 

  • Working in retirement
  • Home equity
  • Inheritance
  • Other savings and investments

You may have also seen the "rules of thumb" that financial experts suggest for retirement savings. If you are in your:

  • 30s: You should have 1 to 2 times your annual salary saved for retirement.
  • 40s: You should have 3 to 4 times your annual salary saved for retirement.
  • 50s: You should have 6 to 7 times your annual salary saved for retirement.
  • 60s: You should have 8 to 10 times your annual salary saved for retirement.

If you don't have even close to that amount saved, you may want to consider encouraging your child to take out student loans and work on beefing up your retirement savings strategy.

Step 3: Make a decision based on what makes sense for your needs.

Once you've made a final decision, take these steps to withdraw from your Roth IRA. 

First, figure out the difference between your contribution amount and earnings. If your contributions exceed the amount of the withdrawal, you won't owe any taxes or penalties. However, again, earnings are taxable. Let's say you decide to take out $20,000 to pay for your son's first year of college. You've made $10,000 in contributions, so $10,000 will come out of contributions and $10,000 comes out of your earnings portion.

Next, you have to report your withdrawal on your taxes. You may want to have your accountant help you address and fill out the right forms. Don't forget other avenues, like filing the FAFSA. Remember that you can pay for college without the FAFSA, such as using a Roth IRA or other methods.

Weigh the Pros and Cons Before You Withdraw

Whether you choose to withdraw from your IRA or not involves a very personal decision. You may see no other way to pay for college. However, remember that you don't always get off scot-free in the tax scenario when you withdraw money for education.

It ultimately comes down to this: You can only access earnings (also known as a distribution) tax-free after you reach 59 ½ and after the money has been in your account for at least five years. If any variable of that sentence changes, all account earnings become taxable — including those used for college expenses.

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