Saving for Retirement and College- How Roth IRAs Can Do It All!

College tuition is a lot more expensive than it was just a few decades ago. Families around the country appreciate that earning a degree without massive student loan debt is a feat that takes years of planning and diligent saving. The reality that college cost increases outpaced inflation over the past several decades is not lost on parents or grandparents with college-aged children. 

Just consider that a public university student in 1987 paid an average tuition bill of less than $3,200 in inflation-adjusted dollars. That student’s child can expect to pay nearly $10,000 for the same education from the same school when they start classes this fall. Rising college costs are a one-two punch for Americans, whose average wages have barely budged over the past few decades. What are families hoping to keep their children from contributing to the $1.4 trillion in outstanding student loan debt to do?  

Families of college-bound students need to know that Roth IRAs can offer a much-needed financial lifeline right before those tuition checks are due. The plans gained popularity in the 1990s and 2000s because they allow savers to invest up to $6,000 after-tax dollars each year into the accounts to grow tax-free to fund retirement. Roth IRAs do not have a minimum age requirement, so young children can have Roth IRAs opened in their names. The only requirements for these accounts are that investors must have an earned income and file a tax return when contributions are made. 

Americans well understand the value of a Roth IRA in retirement. What is less understood is that the plans can play a significant role in tackling college expenses. Savings plans designed to prepare students and parents for college costs often have substantial penalties for withdraws if they are not used for educational expenses. Parents of a child with a 529 or Educational Savings Account deciding not to go to college will pay a hefty tax bill.  

The beauty of using a Roth IRA for educational expenses is that it builds flexibility into education planning. A student who skips or delays higher education does not face added taxes because the funds can be left in the Roth IRA to grow for first-time home purchases, retirement, or other eligible purchases.  

Accessing Roth IRA Funds for College

The unique tax advantages of Roth IRAs come with strings attached. Withdraws made for any non-qualified reason are met with a 10% penalty. Withdraws used to fund qualified higher education expenses are not subject to this penalty and can be made without generating new tax liabilities. The law establishes a Roth IRA as an exciting choice to cover books, room and board, tuition, and other educational expenses.

Parents hoping to qualify for educational assistance and student aid have additional reasons to consider using a Roth IRA to pay for college. The FAFSA (Free Application for Federal Student Aid) does not consider these accounts as assets when evaluating aid eligibility. Need-based aid will not be impacted by money in a Roth IRA until the funds are withdrawn. Once withdrawn, the funds are treated as income earned by the account holder. 

Need-based aid guidelines vary from program-to-program, but students can typically avoid disqualifying themselves from future aid by covering their educational expenses with student loans for the first two or three years of school. They can then withdraw their Roth IRA money and pay off the loans before interest accrues and without disrupting aid grants. 

You Can Borrow For College, Not Retirement

Parents and grandparents can get into trouble when using their Roth IRAs to fund retirement because it can leave them in a dangerous place. Nothing can crack-and-scramble a retirement nest egg faster than a series of tuition payments made a decade before you planned on retiring. Paying for college is like being on a plane experiencing an emergency – you need to take care of yourself before you can help anyone else.  

Before raiding your retirement funds to pay for your child’s education, you should seriously question whether your student needs to attend a less expensive school. Experts agree that when it comes to paying for college, the number one factor determining an education’s affordability is college choice. Picking a community college or school you can cash flow is crucial. 

If a different school is out of the question or you find yourself in a position where the choice is between finishing a degree on time or a mountain of student loans, using a Roth IRA may make sense. Schedule an appointment with a financial planner to decide whether a qualified withdraw makes sense for you.

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