The Roth IRA is an amazing investment vehicle. The SECURE Act of 2019, lower marginal tax rates, and the pending increase in tax rates in 2026 have created both an opportunity and urgency for some investors to convert pre-tax accounts into Roth accounts. With more assets flowing into Roth IRAs the question of, “Can I use these accounts for college expenses?” has similarly grown.
Should You Use A Roth IRA For College?
Ideally you want to save for retirement and college, but if you can only afford to save for one, retirement is generally preferred. The rule of thumb in financial services is, “You can borrow for college, but not retirement.” But it’s not always a bad idea to use retirement assets for college depending on your tax bracket, income, assets, state of residence, liquidity, and other factors.
In some cases you may want to make college savings a priority. If you live in Indiana, for example, residents have access to a state tax credit of 20% on contributions up to $5,000 into one of the state’s 529 plans, resulting in up to a $1,000 tax credit. This is a straight $1,000 reduction on the actual amount of tax owed. Therefore, Indiana residents have a greater incentive to save for college.
Generally, if you can, save for both. If not, carefully consider your unique financial situation before deciding which combination of vehicles to use. And if this is all just too overwhelming, seek the help of a financial professional.
How A Roth IRA Works: The 10,000 Foot View
The Roth IRA allows you to contribute after-tax earned income, select an investment option from the provider, and for those assets to grow tax-free until distribution. So long as you’ve held the assets for five years you can withdraw tax-free if you are over 59 ½ years old, disabled, or making a first-time home purchase. You can also withdraw up to the basis – the amount you put into the plan – at any time, tax-free. And, thanks to the SECURE Act, you can continue to contribute to a Roth IRA indefinitely, meaning there is no age limit, so long as you meet the qualifications.
For 2020, you can only contribute to a Roth IRA if you have income below $139,000 for single filers or $206,000 for married couples filing jointly. The maximum you can contribute is $6,000 annually unless you are over 50, after which you can contribute $7,000 annually. Unearned income, such as from securities or rental properties, among others, cannot be contributed to a Roth IRA.
There are a lot of rules and nuances associated with the Roth IRA, but this covers the bullet points for how the accounts work at a high level.
Using A Roth IRA To Pay For College
Non-qualified distributions from a Roth IRA are typically subject to ordinary income taxes plus a 10% penalty tax. However, that 10% penalty is waived if the withdrawal is used for qualified higher education expenses as defined by Chapter 9 of IRS Publication 970. This definition includes tuition, fees, books, supplies, and equipment, but is more limited than the definitions that apply to 529 plans and Coverdell ESAs.
That said, the Roth IRA has two advantages over 529 plans:
- Assets in a Roth IRA are not included in financial aid calculations. This applies to both the FAFSA (Free Application for Federal Student Aid) and the CSS Profile, the latter of which is used by many (if not most) private colleges and universities. This is great when applying for aid.
- You can invest in almost anything from the Roth IRA provider. If you open a Roth IRA account with Charles Schwab, Fidelity, or TD Ameritrade, for example, you gain access to thousands of mutual funds, ETFs, stocks, fixed income securities, and everything else they offer.
The major downside to using a Roth IRA is that – once you make a withdrawal for higher education expenses – that withdrawal counts as income to the beneficiary for the year in which the withdrawal is made. So, while it hides assets from the aid formula, it does not hide distributions. Further, income to the student has the greatest negative impact on aid calculations, reducing eligibility by fifty cents for every dollar of earned income over the student income protection allowance ($6,660 for the 2019-20 school year). As a result, using a Roth IRA for college funding requires careful planning by timing withdrawals to ensure minimal impact to aid eligibility.
The other downside is the wide array of investment options and conflicting time horizons for the account. This versatility can be a major plus to savvy investors, but other families may not know how to select the right investments for their financial situation and risk tolerance. Having two different time horizons for withdrawals can also become an asset allocation nightmare. Do you anticipate withdrawals in 18 years when the intended beneficiary reaches college age, or 27 years when the owner is expected to retire?
Due to the unique complexities of using a Roth IRA for college expenses, consider seeking the opinion of a financial professional to address your circumstances.
You can find more information about Roth IRAs from the IRS.
If you want to learn about 529 plans visit collegesavings.org, an affiliate of the National Association of State Treasurers. If you’re more technically-minded, you can read IRS Publication 970. There you can find definitions of qualified expenses, institutions, and minutiae of the accounts.
This information does not constitute tax advice and is provided for informational purposes only. Please consult your tax advisor, financial advisor, local taxing authority, and/or plan provider or sponsor for more information.
Brian Boswell, CFP® is a registered representative of and offers securities through MML Investors Services, LLC. Member SIPC. www.sipc.org, 101 Federal St, Suite 800, Boston, MA 02110. Tel: 617-439-4389. CRN202202-259674.
You should carefully consider the investment objectives, risks, charges and expenses of the underlying investments before investing. This and other information can be found in the offering statement, which can be obtained from your investment representative. Please read it carefully before you invest or send money