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With 70 percent of college students graduating with student loans, saving for college in some form has become a fact of life in the world of post-secondary school. This may look like a future student working to save money for college, both before and during college experience, or parents who are able to set aside money. Either way, there are alternatives to putting these savings in a standard savings bank account.

Savings-specific plans were created so that prospective students or retirees are able get more out of the money that is put away. If these investments go as projected, the saver will receive a higher return on their investment as opposed to the smaller interest accumulated in a traditional savings account. A common, education targeted savings plan is a 529 plan, as it is a tax-advantaged or tax-free education savings plan. However, it is lesser known that a Roth IRA, commonly used for retirement, can double as an education and retirement savings plan.

What is a Roth IRA

A Roth IRA account is traditionally used as a retirement savings vehicle. You invest a certain amount of money, which grows through an investment portfolio. This investment portfolio can either be managed by you or a financial expert. Earnings in the account can grow tax-free and the contributions that you put into the account may be withdrawn tax-free at any age, for any reason. A Roth IRA can be used for retirement or other qualified expenses, which may include higher education costs for family members.

“Roth IRAs provide families with tax-free growth for retirement with an option to use the funds for their children’s college expenses,” said Grant Glenn, Managing Partner of Noble Wealth Partners.

The fine print

First, let’s get a handle on the taxes–and tax benefits–of a Roth IRA. Typically, you are subject to income tax based on your yearly earnings. Although you may contribute money you make one year to a Roth IRA, you are still subject to income taxes on that money in the year you make it, unlike a traditional IRA, which has an upfront tax break. While a Roth IRA doesn’t reduce your tax bill in the year you earn or contribute the money, you can withdraw the money tax-free. This is especially advantageous if you expect to be in a higher tax bracket at the time of retirement due to higher personal earnings or increased tax rates.

Withdrawal timing and fund type in the account are other important components of Roth IRAs. The amount of money that you put into the Roth IRA, or the principal portion, can always be withdrawn tax-free and penalty-free. Earnings in the account, or return on the initial investment that you’ve earned, can only be withdrawn for a qualified expense. If earnings are withdrawn prior to retirement or another qualified expense or exception, you will have to pay both income tax that year and are penalized 10 percent of the earnings. Qualified expenses usually refer to retirement, which the plan considers age 59 and a half. However, there are a few other expenses that are qualified as exceptions to Roth IRA early withdrawal penalty. That leads us to college expenses. Other than retirement, qualifying reasons for withdrawal from a Roth IRA includes a first-time home purchase, disability, or death (as in the account can be inherited), college expenses, tax levies, and certain military, medical, or health insurance expenses.

Qualified college expenses:

  • Tuition
  • Required fees
  • Books
  • Required supplies and equipment
  • Room and board

Finally, there is a limit on how much you can contribute to a Roth IRA. If you are under 50 years old, you may only contribute $5,500 per year. If you are over 50 years old, you can contribute an additional $1,000 per year.

Why use a Roth IRA for college?

Simply put, a Roth IRA offers more flexibility than a 529 plan for families who are not sure of a child’s educational future, or of their own future retirement needs. While a 529 plan is a great way to save for college due to its tax-advantages, it is not suited to every family or situation. Something like a college scholarship is exciting and honorable for a child and their parents, but it may make for leftover funds that were intended for college that either cost a withdrawal fee or require some sort of change of plans.  

“The optionality of the Roth IRA can benefit families that do not have to pay as much as they planned for college due to scholarships, education assistance, [or] if their kids decide not to attend college,” said Glenn.

Leftover funds in a Roth IRA can be used for several reasons, but particularly retirement. This allows a family to use Roth IRA funds for both college and retirement expenses.

Glenn explained that Roth IRAs can “be a suitable option for those families that question if they will have enough savings for their requirement.”

Of course, finances, especially when they involve exceptions, are tricky and you should seek advice from a financial expert or other qualified professional if you think that using a Roth IRA for college savings, or anything other than retirement, is an appropriate option for you!

We all know how important it is to save for both college and retirement, so for families that are unsure of their ability to save a significant amount of money for both of these life changes and expenses, a savings plan like a Roth IRA that allows you to combine the two, but makes you more money than interest on a savings account would, may be the way to go.