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 Yes, you're reading that right. You can use your Roth IRA to save for college. As a matter of fact, you can also use a Traditional IRA to pay those college expenses. And 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 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 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've already got 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've got saved for those retirement years.
But being the ultimate financial planner, you've even got some money socked away 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've got lots of 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've still got 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 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. In case you didn't realize an IRA could be used before age 59 1/2 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 expenses.
So 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.
And you're not limited to your children when it comes to paying for college with an IRA. The tax law says those eligible 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 hold true of traditional IRAs and certainly Roth IRAs - if you qualify. All of these accounts grow either on a tax deferred or tax free basis.
But there are a couple of other benefits to using an IRA to save for college. For one, 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. That's 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 attended 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, don't wait too long. In addition to the withdrawal exceptions noted above, you need to you hold the IRA for 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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