If you are hoping that your children will go to college Sunday, you’ve more than likely thought about the best way to put money aside to pay for. Utilizing a 529 plan is an excellent idea of course, but one savings plan that most people overlook when planning for a child’s college education is a Roth IRA.
Of course a Roth IRA is an excellent retirement savings plan but, when it comes to the college, it’s actually quite good as well. The difference between a Roth IRA and a 529 plan is that a Roth IRA can be used for both retirement and college expenses, while a 529 plan can only be used to cover college costs and expenses.
A Roth IRA any tax reductions of course but it also grows tax-deferred so, with just a little planning, it can be an ideal source for funding the higher education needs of your child. The reason is that withdrawals from Roth IRAs are exempt from withdrawal penalties if the funds withdrawn by used for educational expenses like tuition, books, room and board and fees.
2 caveats are that only the contribution portions of a Roth IRA balance can be withdrawn tax-free when used for college costs and any earnings will be taxable for people under the age of 59 and also those over 59 ½ who haven’t had the Roth IRA for at least 5 years.
Withdrawals from a Roth IRA however are treated as “return of contribution” withdrawals first, and as earnings second. What this means is that anyone who has contributed $5000 per year for the last 5 years can withdraw up to $25,000 for qualified educational expenses and do it tax-free.
While there certainly are plenty of states that offer tax deductions for funds that have been contributed to a 529 plan, there are millions of people who live in the 8 states that don’t and, in those states, a Roth IRA is definitely an excellent and flexible alternative to the 529.
Even better, any funds that are left over after withdrawing for college expenses can be converted to retirement income with no tax consequence or penalties. In other words, if your son or daughter don’t use all of the money that you withdraw, it can be used to supplement your own retirement income as well.
Some of the disadvantages that Roth IRAs have include the fact that there are contribution limits and that you need to have earnings in order to be able to contribute, which means that retirees most likely won’t be able to participate. High income earners are also prohibited from using this excellent retirement savings tool, including single taxpayers with income over $114,000 and married couples with over $181,000 of income per year.
In short, here are the advantages and disadvantages to using a Roth IRA to pay for college costs.
- Flexibility. Unused funds can be used for retirement
- Interest can accumulate tax-deferred
- Will when funds are withdrawn for qualified educational purposes, entities are exempt
- Contribution limits are quite strict
- In order to contribute you must earn money, so retirees usually don’t qualify
- High income earners are prohibited from participation
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