Should I Use a Roth IRA to Pay for College?
Since you’re checking out a post about Roth IRAs, I’ll assume you already know that there are several exceptions the IRS provides to early withdrawal penalties from Roth accounts such as:
- Withdrawal of contributions (always tax and penalty free)
- 72T distributions
- Qualified reservist distributions
- Medical expenses that exceed 7.5% of your adjusted gross income
- Paying medical insurance premiums after losing a job
- Recovery from a qualified disaster
- Adoption or childbirth expenses up to $5,000
- Or to pay a fine to the IRS
In addition to this series of exceptions, you can also withdraw funds from a Roth IRA to pay for qualified educational expenses.
Qualified education expenses include:
- Tuition and fees
- Books and supplies
- Room and board (up to certain limits assuming the student is enrolled at least half time)
- Equipment required for attendance
It likely won’t come as a surprise that many diligent savers find themselves with healthy Roth IRA account balances at about the same time in life that they are searching for ways to finance the education of their children.
Naturally, for many a Roth IRA seems like a convenient way to manage a rather hefty financial burden while avoiding a significant impact to regular cashflow.
Let’s walk through why education expenses may or may not be the best way to use your Roth IRA.
Pros for Using Your Roth IRA for College
1) Flexibility
If your kid doesn’t go to college or drops out, you can still use the money in retirement.
Funds in tax-advantaged plans designated for education are more or less reserved for education, or the penalties for using the money elsewhere make doing so particularly unattractive.
2) Financial Aid Impact
Since Roth IRAs are retirement assets, they are not included in calculations to determine a child’s eligibility for need-based loans, grants, scholarships, etc.
However, withdrawals from your Roth IRA for education expenses are viewed as income that will directly impact your child’s future eligibility for these need-based assistance options.
3) Investment Options
Regardless of whatever other tax-incentivized options you are considering for financing education expenses, it is unlikely that any of those options will offer the same degree of investment flexibility you can get in a Roth IRA.
With a Roth IRA you get to choose your custodian and, unless you choose poorly, you will have access to a plethora of investment options like stocks, bonds, mutual funds (indexed or actively managed), ETFs, treasuries, money markets, CDs, etc.
Many education savings plan accounts offer a degree of flexibility, but that can’t rival what’s available in the typical Roth IRA.
Cons for Using Your Roth IRA for College
1) It’s a Hit to Your Retirement Savings
The first and most significant downside to using your Roth IRA for education expenses is that it reduces your retirement savings.
In my opinion, this is a difficult hurdle to overcome.
I have kids and I love them very much. They’re 12 and 9 years old as I write this and, thanks to my wife’s genetic contribution, they are exhibiting some very promising signs academically. We do expect them to go to college one day.
My wife and I are actively saving for that opportunity, but we do not plan to use our retirement accounts to finance any of their education.
This decision is rooted in the belief that it will be a far greater gift to our children to remain financially independent as we age than to pay for their postsecondary education.
After all, there are plenty of ways to obtain financial assistance for college, but they don’t give loans for retirement.
2) Contributions Are Limited
A second disadvantage of using your Roth IRA for education is the limited contribution amount.
In 2024, individuals can contribute up to $7,000 and $8,000 if 50 or older.
In all honesty, if you saved and invested this amount for 18 years it would probably come close to fully funding the cost of attendance for four years at an in-state public institution in many parts of the country.
However, revisiting the first con, this doesn’t leave much or any of your Roth IRA for retirement.
Being married would help because it gives you the ability to establish multiple IRAs, but if you have multiple kids to put through college, that won’t take you much further.
For most states, 529 savings plans allow contributions up to hundreds of thousands of dollars per beneficiary before contributions are prevented, meaning you can save far more in one of these plans than you can in a Roth IRA.
3) No State Income Tax Deduction
The next drawback of using your Roth IRA for college is that your Roth contributions won’t earn you a state income tax deduction.
On the other hand, 529 savings plans could save you thousands of dollars depending on where you live.
In 2024, there are only four states that do not offer any sort of state income tax deduction for 529 contributions. Those states are Kentucky, North Carolina, California, and Hawaii.
There are 37 states that offer a deduction and nine of those 37 offer the deduction regardless of which state’s plan you select.
The other nine states don’t impose income taxes at all so, naturally, there is no option for a deduction.
4) Earnings Are Taxed
Last but not least, if you use your Roth to fund college you will owe income tax on any earnings you withdraw from the account.
To be clear, contributions remain tax free, but earnings from invested contributions are not when used for education.
This basically means the only benefit for using a Roth account is to allow your contributions to generate earnings that you eventually leave in the account.
If you do remove earnings and pay income tax on them, you’d have been better off just investing after-tax dollars in a taxable brokerage account and paying capital gains taxes on long term gains which are taxed at lower rates than income.
About 529s
You may have noticed that I compared Roth IRAs to 529 plans a few times when explaining the pros and cons of using a Roth IRA.
If you’re wondering why I did that it’s because a 529 plan could basically be considered a Roth for education.
Like Roth IRAs, 529 plans allow one to make contributions to an account on an after-tax basis, though many contributions are deductible from state income tax.
Also, all earnings and withdrawals can be made completely tax-free, assuming the money is used for a qualified education expense.
The primary drawback of 529 plans is that withdrawals are only tax and penalty-free if used for education.
So, if your chosen beneficiary decides not to go to college, you can either pick a new beneficiary (who will need to be a relative) or you can pay a 10% penalty and income taxes on your earnings to withdraw the balance.
This lack of flexibility is THE major drawback to 529s. However, SECURE Act 2.0 did introduce a new path to moving some 529 money out of the account under certain requirements.
Beginning in 2024, you can roll unused 529 funds into a Roth IRA for the benefit of the designated beneficiary of the account, but…
- The beneficiary must have earned income equal to or in excess of the amount rolled into the account;
- The amount rolled over to a Roth is counted against the beneficiaries annual Roth IRA contribution limit;
- The total amount rolled into a Roth cannot exceed $35,000.
There are other limitations to these rollovers. You should dig into the details if you want to go this route, but at least there is a glimmer of hope for your leftover 529 money if you happen to have too much in the account.
What Do the Martin’s Do?
Obviously, I can’t give personal advice through a blog post, but I can tell you about the strategy my wife and I use for college saving and investing for our kids.
The first thing is we don’t tell them that we’re saving for their college education. We feel like it might sap their motivation to pursue scholarships or even strive for excellence academically if they know much of it will be paid for by Mom and Dad.
Next, we use 529 plans as much as practically possible.
Financially, our goal is to save 80% to 90% of the cost of attendance for four years of study at a public in-state institution where we live.
In 2024, where we live in Alabama, this is about $120,000 per student.
We have two kids. My son will start college in 2030 and my daughter will be three years behind him, starting her college years in 2033.
Currently, we are on track to overfund my son’s 529 a little bit and we will run out of money in my daughter’s account in her 3rd year of school.
The single most important thing we did to get these accounts off to a good start was to seed them with large contributions when they were just toddlers.
I am a big believer in the power of compounding interest, so we knew the earlier we started the better off we’d be.
For each child, we contributed $5,000 when they were infants, $3,000 when they were one, and another $2,000 when they were two years old.
After that, I ran projections for the growth in the accounts (which has been quite aggressive thus far) and forecasted the cost of attendance using an inflation rate of 3.5% annually.
These projections led us to the decision to contribute $100 per kid per month from then on.
Each year, I update the projections for the account growth and the cost of attendance and make adjustments if necessary.
If the 529s run out of cash before the bills are all paid for school (which we fully expect) then we will pay for the rest out of our income or taxable brokerage accounts from a cash equivalent investment like CDs or a money market fund.
We will never use our Roth IRAs or any other retirement assets to pay for education expenses for our kids because we believe preserving our retirement income and savings is more important to their future than funding their education.
It’s not that our retirement is more important than their education, there are just so many more resources to pay for school than there are for retirement. We do not want to jeopardize our financial independence and become a burden to them in any way.
Besides, if we have any leftover Roth money it will likely go to them as a tax-free inheritance anyway.
To me, the lack of flexibility in managing extra 529 money is enough of a deterrent that I’d rather come up short and cover the remaining costs with money that doesn’t receive any special tax treatment and isn’t encumbered by a 10% withdrawal penalty.
There are people who will ardently argue that a Roth IRA is the better tool for funding education. Everyone is welcome to their own opinion, but I feel like giving up tax-free growth in a Roth IRA is too costly a way to fund education.
What If It’s My Roth?
I want to cover one final caveat to this whole discussion.
Maybe you’re the one with a Roth IRA and you are the one needing money to fund your own education.
In this case, I still lean strongly toward preserving the Roth, especially if you are under 40 years old.
The reason is you can’t get the long-term tax-free growth back into your Roth once you remove money from the account. That’s a high price to pay, even more so than a parent around 50 paying for their kid’s college.
There are some exceptions.
If you absolutely have no other way to pay for education or the only available loans come with exorbitant interest, then maybe I would tap the Roth then.
But I find it difficult to believe that there isn’t someone who will lend money to a prospective student at a reasonable interest rate. Tap the Roth as a last resort.
Oh, and please do yourself a favor and select a course of study that will actually generate a meaningful income for you. Just because you can major in X-box doesn’t mean you should.
Wrap Up
Generally speaking, tax-advantaged accounts are great for saving money for the purpose for which they were created (i.e. retirement, healthcare, college, etc.)
Even though exceptions exist to provide some flexibility with these accounts, you are probably better off using each one in the manner it was intended to be used.
