Parental savings cover 44% of college costs according to Education Data. Many parents would like to start saving for their child's education early, but they often don't know all the options. Saving for college with a Roth IRA is a great alternative to a 529 savings account. It is ideal if you waited until later in life to have kids or want to contribute to your grandkids' education.
A Roth IRA allows you to contribute $6,000 per year with those over age 50 allowed to contribute an additional $1,000 per year. You don't need to delay starting your Roth IRA. The sooner that you open your account, the faster you can begin building wealth. A Roth IRA is flexible in when you can contribute funds to it. You can make contributions in a lump sum or throughout the year.
Roth IRA Benefits
The earnings and contributions to a Roth IRA grow tax-free. While the earnings can't be withdrawn at any time, the contributions can be withdrawn penalty-free whenever you need them. After the age of 59 1/2, if it has been five years since your first contribution, all the money in the Roth IRA can be withdrawn without a penalty. This means that all the withdrawals can be devoted to college expenses.
You are eligible to contribute to a Roth IRA at any time as long as you have a taxable income and don't make too much money. For example, if your adjusted gross income is over $198,000, the amount that you can contribute will be reduced. Roth IRAs do not have required minimum distributions, so you will be able to keep your money in the account if you don't use it.
A Roth IRA isn't limited to educational expenses. If you find that your child doesn't need all the money in the Roth IRA, the money that isn't used for college can be used to fund your retirement.
Roth IRA Disadvantages
There are some downsides to saving with a Roth IRA. The annual contribution to a Roth IRA is very low compared to a 529 savings contribution. There also are no state income tax deductions for Roth IRA contributions.
Giving away the Roth IRA money that you have saved and invested reduces the amount of money that you have for retirement. It is a good idea to keep some money allocated for your retirement if you plan on using the Roth IRA funds to help your child with college.
When a Roth IRA is better than a 529 savings plan
There are times when a Roth IRA will be a better option for your child. If you are saving when your child is young, you may want to avoid the taxes and penalties. You may also want to have the flexibility of using the money for your own retirement. A Roth IRA also gives you a bit of control over how the money is invested and used.
The Roth IRA withdrawals count against you when applying for financial aid. The parent assets can reduce the amount of financial aid by a maximum of 5.64%. Money withdrawn from a Roth IRA will count as income on the FAFSA (Free Application for Federal Student Aid). The FAFSA uses the income from the prior two years to determine the students' eligibility. It is best to use a 529 savings account for the first two years and Roth IRA withdrawals in the final two years.
The 529 savings account is great when you know that your child is going to college and will spend the funds towards education expenses. The 529 withdrawals for qualified expenses don't count towards your income on the FAFSA, but the funds must be used for education.
The following are four instances when it is better to use a Roth IRA instead of a 529 savings plan.
- Your child doesn't want to go to college.
- You may need the money for your retirement.
- You want to control how the money will be invested.
- Your child won't need the money until the last two years of school.
Creating a college savings plan
A Roth IRA provides many advantages when it comes to saving for your child's education. Since the yearly contributions are limited, you may not want to rely only on a Roth IRA, especially if you are planning on using the funds for retirement as well. It would be wise to use a combination of a 529 savings plan and a Roth IRA. Whether you have a toddler or a teenager, it is never too early to start saving for your child's future.