I hear this question a lot since a Roth IRA allows you to withdraw money to pay for qualified higher education expenses without paying a 10% early withdrawal penalty. While there are both advantages and disadvantages to using a Roth IRA for your children’s college education depending on your own personal situation, the short answer for most people is… NO, you should not use a Roth IRA to save for your children’s college education.
Let’s first talk about some of the advantages of using a Roth IRA as opposed to a 529 account or Coverdell Education Savings Account (ESA).
- Higher Contributions Allowed (sometimes) – Contributing to a Roth IRA may allow you to save more than an ESA, depending on how many kids you are saving for. Currently, you are allowed to contribute $5,500 for the year ($6,500 if you’re over 50) to a Roth IRA, while ESA’s only allow you to contribute $2,000 for the year, per child. If you are saving for just one or two children, you can save more inside of a Roth IRA. However, if you are saving for three children or more, you aren’t able to save as much as you would inside an ESA.
- Flexibility – In the event your child doesn’t end up going to college, you can keep the money in the Roth IRA and use it for your retirement instead. In this scenario, if you had a 529 or ESA, you would need to change the beneficiary of the account to another family member to use for their education, or be penalized for withdrawing the money for non-qualified education expenses. You also have the flexibility of controlling what you invest in inside of the Roth IRA; 529 plans have limited investment choices.
Now that you know the advantages, I’ll explain what some of the disadvantages are:
- While you are able to withdraw your contributions into the Roth IRA tax-free and penalty-free, you are required to pay taxes on the earnings, even if you are withdrawing funds for qualified education expenses. If you wait until age 59 ½ to withdraw the earnings in the account, you don’t have to pay taxes or a penalty. However, most parents need to pay for their children’s college before they reach 59 ½. If you have a 529 or ESA, any funds in the account (contributions and earnings) are able to be withdrawn tax-free and penalty-free when used for qualified education expenses.
- You don’t receive any tax-breaks when using a Roth IRA for qualified education expenses; contributions to an ESA do not qualify for state tax deductions either. For Kansas residents, contributions to any Kansas or non-Kansas state-sponsored 529 plan up to $3,000 per beneficiary per year for an individual taxpayer, and $6,000 per beneficiary per year for a married couple filing jointly, are deductible in computing Kansas taxable income. If you live in a state other than Kansas, you will want to look-up what the requirements are to receive a state tax deduction for contributions to a 529.
- Since you are limited to contributing $5,500 a year into a Roth IRA, using a Roth IRA for education expenses instead of retirement could really hurt your retirement savings options.
Overall, the tax savings that you can earn by investing in a 529 or ESA instead of a Roth IRA make this decision pretty simple. While there are a few instances that make sense to utilize a Roth IRA or ESA for your college savings, I almost always recommend my clients use a 529 account. If you have any further questions regarding how to save for your children’s college education, please give me a call at 913.402.6099.
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John P. Chladek, MBA, CFP® is the President of Chladek Wealth Management, LLC, a fee-only financial planning and investment management firm specializing in helping families and couples who are not yet retired realize their financial goals. For more information, visit https://www.chladekwealth.com.