Can You Use Your Roth IRA to Pay for College?December 1, 2021
When it comes to saving for college, there are several different options available, one of which might not seem like an option at all. But using a Roth individual retirement account (IRA) for college savings can be a good way to pay for college expenses.
In fact, because of the rising costs of college, more and more people are doing so. But while withdrawing money from a Roth IRA can help you cover the cost of a child’s education, it’s important to understand how that decision will impact your retirement and some alternatives you can explore.
How to Use a Roth IRA to Pay for College
Can a Roth IRA be used for college? Absolutely. But it’s not as simple as taking money out of a savings account. There are rules around using a Roth IRA for college expenses. More specifically:
- You can withdraw up to the amount you’ve contributed to the account without penalty or taxation.
- If you withdraw money early for qualified education expenses, you won’t be subject to the 10% early-withdrawal penalty — though your withdrawals will still be subject to income tax.
- If you’ve reached the age 59½, you can withdraw both your contributions and earnings without penalty or taxation.
That said, not everyone can contribute to a Roth IRA. If you’re married and file a joint return with your spouse, you cannot contribute directly to a Roth IRA if your modified adjusted gross income is $208,000 or more. If you’re a single filer, that limit is $140,000. You can also only contribute up to $6,000 annually (or $7,000 if you’re age 50 or older).
Pros & Cons of Using Your Roth IRA to Pay for College
If you’re considering using a Roth IRA for college expenses, it’s critical that you understand both the benefits and drawbacks of doing so.
- Flexibility: With a 529 plan or Coverdell Education Savings Account, there’s just one beneficiary, and if you want to use the funds for another child, you have to update the beneficiary on the account. With a Roth IRA, on the other hand, you can use the money for any of your children without needing to jump through hoops.
- Tax-free growth: Roth IRA contributions are made on an after-tax basis, so your funds grow tax-free. If you do it right, you can avoid most (if not all) potential tax consequences when withdrawing for college expenses.
- More investment options: If you opt for a 529 plan, you’ll typically be limited in how you can invest your account funds. With a Roth IRA, you’ll have more brokerage firms to choose from, as well as investment options with the firm you choose.
- Low contribution limits: Again, you can only contribute up to $6,000 annually (plus $1,000 more in catch-up contributions if you’re eligible). With a 529 plan, there is no annual contribution limit.
- Not everyone can qualify: If you’re a high income earner, you may not be able to contribute directly to a Roth IRA, making it more difficult to use this option to save for college.
- No state tax benefits: In some states, 529 plan contributors can get a tax deduction or credit on the money they put into their college savings plans. Roth IRAs don’t provide that same benefit.
- Taxes may still apply: There are ways to avoid taxes on Roth IRA withdrawals, but once you withdraw all of your contributions, you’ll be subject to income taxes unless you’ve reached age 59½.
- It’ll impact your retirement savings: Any money you take from your Roth IRA to pay for college expenses will no longer earn gains that you can use for your retirement. If you’re not already on track to retire when and how you want, it may be best to leave your retirement savings where they are.
How a Roth IRA Withdrawal Affects Financial Aid
Roth IRA withdrawals used for college expenses will count as untaxed income on your child’s Free Application for Federal Student Aid (FAFSA) in the following year. Both your taxable and nontaxable income are used to calculate your expected family contribution, so your child may miss out on need-based financial aid that they might otherwise receive.
So if you’re thinking about using a Roth IRA for college expenses, think carefully about how it’ll affect your child in future academic terms.
Roth IRA vs. Traditional IRA to Pay for College
You can use either a Roth IRA or a traditional IRA to pay for qualified education expenses. But because of the way the two different retirement accounts are taxed, it’s generally better to use a Roth IRA.
While Roth IRA contributions are made on an after-tax basis, traditional IRA contributions are made pre-tax. In both instances, you can withdraw money for qualified education expenses and avoid the 10% early-withdrawal penalty. But because both your contributions and gains in a traditional IRA haven’t been taxed yet, those withdrawals will always be subject to income tax.
Alternatives to Using Your Roth IRA to pay for College
Depending on your situation, there are plenty of alternatives to using a Roth IRA to fund your child’s college education. Here are some other ways to help your child pay for college:
- Using a 401(k) to pay for college
- 529 savings plans
- If you have time, start a college fund
- Private student loans
Using a 401(k) to Pay for College
You can technically use 401(k) funds to pay for college, but your options will vary depending on your employer and the 401(k) plan. For example, some may allow early withdrawals while you’re still an employee, but you may need to prove that you’re experiencing financial hardship to qualify.
And if you’re under 59½, you’ll likely be subject to both the 10% early-withdrawal penalty and income taxes.
One way to get around this is to roll your 401(k) into a Roth IRA. But if your 401(k) is a traditional 401(k) and not a Roth 401(k), that could result in a significant tax bill because you’re converting pre-tax dollars to an after-tax account.
529 Saving Plans
A 529 college savings plan is a more traditional way to save for college, and it can offer certain benefits that a Roth IRA can’t. For example, some states offer tax breaks on contributions, and you don’t have to worry about a low annual contribution limit.
Also, your 529 plan funds grow tax-free and can be withdrawn tax-free for 529 plan qualified expenses. However, there’s only one beneficiary on this type of plan, and if your child doesn’t need all the funds, you’ll be taxed and possibly even penalized for withdrawing the money for other reasons.
If You Have Time, Start a College Fund
It’s never too late to start a college fund to save as much money as you can before tuition is due. This can be in the form of a 529 plan, a Coverdell Education Savings Plan or simply a savings or investment account.
Whatever you don’t cover with your savings, you can make up the difference with federal student loans, private student loans, grants and scholarships.
Private Student Loans
If you want to avoid impacting your retirement savings, private student loans can be a great option to pay for college, especially if you’ve reached your federal student loan borrowing limit. With good credit or a cosigner who has good credit, you can potentially qualify for a low interest rate and a flexible student loan repayment plan.
Apply for Private Student Loans Today With ELFI
ELFI offers private student loans for undergraduates, parents and graduate school with competitive interest rates and flexible repayment options.* Depending on your preference, you can begin paying your student loans while you or your child is still in school, or you can defer them until after graduation.
If you’re thinking about using private student loans to help cover the cost of college, use ELFI’s student loan calculator to estimate your monthly payments and overall costs.*