Saving for College via Roth IRA

Saving for college is an enormous financial undertaking, and rivals the burden of saving for retirement.  These two financial challenges have something in common too.  You can use your Roth IRA to save for college.  In fact, it’s also possible to use a Traditional IRA to help pay for college expenses.  For some taxpayers, using an individual retirement account to create a college fund makes a lot of sense.

College Savings Accounts

We’re all familiar with the notion that 529 plans and Coverdell IRAs can be used to pay for college.  In fact, the very reason these types of savings accounts were created was to help pay for college expenses.  But that doesn’t mean you’re limited to these two types of funds.  The tax law, as administered by the IRS, is actually quite flexible when it comes to using an IRA to pay for college.

Saving for College Using Retirement Plans

Let’s say you already have a pension where you work, and you’ve been fully participating in your employer’s 401k plan for years.  To sum things up, you’re pretty comfortable with the money you have saved for your retirement years.

But being the ultimate financial planner, you even have some money placed in a Roth IRA or a traditional IRA.  Since you’re comfortable with your retirement planning strategy, your focus is now shifting to paying for college.  Guess what?  You have several options when it comes to how you’re going to use those IRAs, and that includes using the money to pay for college expenses.

IRAs as College Savings Accounts

Even if you’ve never funded a Traditional IRA or a Roth, you still have options.  In fact, one of the nice things about using an IRA to help pay for college is simply the flexibility of the accounts themselves.  You can use them to pay for retirement, or you can use them to pay for what are called qualified education expenses; more on that topic later.

IRA Withdrawal Rules Include Higher Education

The reason you can use an IRA to pay for college has to do with the fairly generous exception rules when it comes to making an IRA withdrawal before age 59 1/2.  If you don’t meet one of these exceptions, then you’re subject to tax penalties.  An IRA can be used before age 59 ½, and here are some of the early withdrawal exceptions for Roth IRAs:

• You are disabled
• You use the distribution to pay certain qualified first-time homebuyer expenses
• The distributions are part of a series of substantially equal payments
• You have significant unreimbursed medical expenses
• The distributions are not more than your qualified higher education expenses, which would include college / university costs

If you’re only removing enough money to pay for qualified higher education expenses, then you don’t pay any tax penalties on the monies removed.  But what exactly are qualified higher education expenses?

Qualified Higher Education Expenses

For purposes of avoiding any penalties, qualified higher education expenses include tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution.

An eligible educational institution is defined as any college, university, vocational school, or other postsecondary educational institution that is eligible to participate in a student aid program administered by the Department of Education.  This definition includes nearly all accredited public, nonprofit, and privately owned / profit-making postsecondary institutions.

In addition, you’re not limited to your children when it comes to paying for college with an IRA.  The tax law says eligible individuals include yourself, your spouse, your children, your spouse’s children, your grandchildren, or your spouse’s grandchildren.

Benefits of Using an IRA to Pay for College

All of the government sponsored college savings plans, 529 plans, and Coverdell IRAs, provide you with very generous tax benefits.  The same holds true for traditional IRAs, and certainly Roth IRAs.  That is, if you qualify, all of these accounts grow either on a tax-deferred or tax-free basis.

But there are several other benefits to using an IRA to save for college.  Under current law, you can shelter retirement accounts when you apply for financial aid.  This means these IRA funds are not viewed as an account that can be used to pay for college.  This is a benefit that is unique to using an IRA to pay for college.

The second big benefit to using an IRA to pay for college has to do with asset control.  If your child decides to leave college, or not attend school, then you simply use the money to pay for expenses in retirement.

If you like the idea of using a Roth IRA, or setting up a Traditional IRA to pay for college, then don’t wait too long.  In addition to the withdrawal exceptions noted above, you need to hold the IRA for at least five years before withdrawing funds.  Besides, the sooner you start saving, the easier it is to pay for school later on.

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