Before College: Roth IRAs — A College Savings Option

Your newborn baby or young child may or may not go to college. If they do, you want to help him avoid massive student loan debt. But you’re line of work generates middle-class incomes. So where can you save the money you’ll need to achieve this worthy goal?

How about a Roth IRA?

What Are IRAs?

A Roth IRA is an individual retirement account.

The maximum that may be deposited into a Roth IRA is $5,550 per year, or $6,500 per year once you’re 50. This shrinks for high-income individuals and couples.

You pay no federal income taxes the earnings that grow your Roth IRA’s balance, but whatever you withdraw from that balance is taxable. Generally, there’s also a 10% penalty on withdrawals you make before you turn 59.5.

Using IRAs for College

Regardless of your age, there’s an exception under which you pay no penalty on withdrawals that don’t exceed qualified education expenses for the Roth IRA’s beneficiary at an eligible postsecondary institution.

To calculate qualified education expenses:

1. Add charges for tuition, fees, books, supplies, equipment, and special needs services the beneficiary must pay to attend the school;

2. If the beneficiary is enrolled at least half-time, add room and board, too, up to the lesser of (a) the school’s published room and board amount, or (b) the beneficiary’s actual charges for living and eating in school-owned and operated housing; and

3. Subtract the beneficiary’s tax-free education assistance — i.e. the untaxed portions of grants and scholarships; distributions from Coverdell education savings accounts; and educational assistance from employers, the Veterans Administration, and other sources.

An eligible postsecondary institution is a college, university, or vocational school eligible to participate in the federal student aid programs.

The beneficiary may be you, your spouse, or your child and grandchild, or your spouse’s child and grandchild.

Pros and Cons

Roth IRA advantages for college savings include:

Flexibility to use them for either college or retirement;

Tax-free growth;

Contributions alone can add up to at least $99,000 if you maximize them for 18 years;

Their balances don’t count toward Expected Family Contribution (EFC) when the beneficiary applies for financial aid, whereas 5.64% of other assets do.

Disadvantages include:

Amounts spent on college are lost for retirement;

Contribution limits are lower than for many other college savings instruments;

Withdrawals are taxed, whereas 529 plan withdrawals aren’t;

Untaxed portions of one year’s withdrawals count toward the beneficiary’s financial aid EFC in two more years.

Roth IRAs are good retirement saving options. They’re also good college saving options if you’re middle-class and not yet sure whether the beneficiaries will pursue postsecondary learning.

Contact College Affordability Solutions for free consultations if you’re looking for options to keep postsecondary educational costs within your means.

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