Is it OK to Use a Roth IRA to Pay for College Expenses?

••• Creative RF/JGI/Jamie Grill

The Roth IRA is an excellent way to save for retirement and offers tax-free accumulation and withdrawal of earnings. Roth IRAs may also be used for non-retirement financial goals, such as funding college for a loved one. But should a Roth IRA be used to help pay for college expenses? This is a question considered by many parents and grandparents as the price tag for higher education continues to rise.

Roth IRAs Offer Flexibility

Roth IRAs offer flexibility when it comes to accessing your original contributions. Because Roth IRA contributions are made with after-tax dollars, these can be taken out at any time without tax or penalty. This creates an opportunity to use a Roth IRA as a supplemental source of college funding or any other non-retirement-related financial goal. Tax-free withdrawal of any earnings growth applies if your account has been opened for at least 5 years and distributions occur after age 59 1/2.

Core Financial Plan Before Saving for College

Most financial planners agree you should have a solid financial foundation in place before considering participation in any savings plan for college.

The general guidelines include these steps: 

  1. Set aside funds to cover emergency expenses (think “starter” savings; usually $1,000-$2,000).
  2. Contribute enough to a retirement plan at work to capture the full employer match, if available.
  3. Eliminate any high-interest consumer debt such as credit cards or personal loans (e.g. greater than 6%).
  4. Fully fund your emergency savings account with enough money to cover 3-6 months of living expenses.
  5. Save as much as you can in a 401(k) or 403(b) plan, IRAs, and health savings account to meet retirement goals. Somewhere in the range of 10-20% of pay or more is ideal.
  6. Protect your family and your wealth by maintaining life, health, disability, and liability insurance.
  7. Create and maintain crucial estate planning documents such as wills, living wills, and powers of attorney that are current and up-to-date. 

Why Paying for College Is a Secondary Priority

Before setting aside any money for college, first evaluate if you are on the right track to meet retirement income goals.

While it is possible to borrow money for college, it is not wise to rely on debt to fund your retirement dreams. So, as a general rule, retirement goals should take precedent over college savings on the priority list. 

Putting retirement ahead of college isn't always the financial guidance parents or grandparents want to hear. Most parents are predisposed to provide children with the best experiences and opportunities possible. But if you put saving for college ahead of retirement, the outcome could be delaying retirement (or lacking the money to retire on your terms), and selling investment property or other assets earlier than desired—thereby creating unnecessary financial stress and frustration. 

The good news is that Roth IRAs provide parents with an opportunity to feel like they are making some progress saving for retirement in an account that can also be used to help pay for college down the road.

Roth IRAs Provide More Options for College Planning

The majority of 529 plans, which are a typical way parents save for college, offer a limited amount of investment options to choose from. Roth IRAs are not an actual investment but instead represent a type of retirement savings account that allows for various types of investments—stocks, bonds, mutual funds, ETFs, REITs, CDs, etc. To take full advantage of the tax-free growth of earnings, it is generally wise to seek out growth-oriented investments for a Roth IRA.

Downsides to Roth IRAs

Like many financial decisions, there are some downsides to using a Roth IRA to help pay for college. Here are a few:

  • Roth IRAs are subject to income limitations. Roth IRAs have income limitations which make married couples filing joint returns ineligible to contribute directly to these accounts if they earn more than $198,999 in 2018.
  • Annual contribution limits are much lower than for 529 plans. Roth IRAs have lower contribution limits than other college savings vehicles. Roth IRA contribution limits are significantly lower than the higher limits found with 529 college savings plans.
  • Impact on financial aid. Roth IRA distributions to pay for college expenses count as untaxed income on next year's FAFSA and this could reduce your child’s eligibility for need-based financial aid. Roth IRAs are still a low-impact asset for financial aid purposes and the total asset value is not reported on FAFSA.

When 529 Plans Come First

529 plans are usually a better option when saving for college is the primary goal.

529 plan investments grow tax-free and distributions used to pay for qualified education expenses are also tax-free. Now you can also use some 529 plan proceeds for elementary and high school costs.

For parents or grandparents already on track to meet retirement goals, it is usually more beneficial to look at 529 plans first for college savings. But when those college funding goals require a little more flexibility, or the likelihood of your child attending college is less certain, a Roth IRA becomes more appealing.