When it comes to saving for your kids college savings, most financial advisors will put college savings a notch below saving for retirement. Wouldn’t it be nice if there were a way that you could do both without potentially risking one or the other?
Using your Roth IRA as a college savings vehicle could be one such option.
When you withdraw money from your Roth IRA to pay for your children’s college, you can withdraw your contributions without tax or penalty.
If you put $5000 per year into your Roth, over a 15 year period you could theoretically withdraw up to $75,000 because this is your total contribution.
Advantages of Using a Roth IRA for Kids’ College Savings
Flexibility to Make Important Financial Decisions in the Future
If you save in a Roth, the money is there to be used according to your child’s actual need. If your little girl gets a half off tuition scholarship, her school costs will be dramatically less than you would have anticipated when she was in diapers.
Here are some frequently asked ‘what if’ questions regarding a child’s college savings:
- What if she doesn’t go to school?
- What if she isn’t deserving of the money?
- What if you work for the school and get big discounts because of it?
- What if she has her own money to pay for school? You kids do plan to work in school, right?
With the Roth you can use what you have available based on the need when she is 18 instead of trying to guess when she is 2.
What happens to money in a Coverdell ESA if my child doesn’t go to school or use the money?
If your child does not use the money for school, you can roll the money over to a relative’s school payments. But, seriously, if you had been saving for your niece, do you think you would have intentionally contributed as much to college savings?
In 2010, the Roth contribution limit is $5,000. For a married couple, this means they can contribute up to $10,000 per year. Compare this to the Coverdell ESA which only allows you to contribute $2,000. Families who are not fully maxing out their contributions can use some of their allowance for college savings. Since my wife works at home there is no way we will max out $10,000 on my income.
Possible Financial Aid Advantage
When applying for financial aid, part of the decision is made on the assets of the family. Currently, a Coverdell ESA will be considered an asset when applying for loans. Funds in a Roth IRA will not – at least until withdrawn. As such, when you first apply for financial aid, if the money is in the Roth it will not be considered an asset when it comes to the financial aid decision. However, if you then withdraw the money, that amount of money would be considered an asset the next year when you applied. One obvious way around this is to get student loans and not touch any of your Roth IRA money until after your child was done with school and then withdraw the money to pay off those loans. This is something you will want to look into very carefully to be sure you completely understand how your choices impact financial aid.
More Options in a Financial Crisis
Since the future is unknown to us, if something happened along your way to saving for college and you were unable to continue to work or have bill payment issues, the Roth will provide some important savings for you.
It is better for your kid to work and borrow a little bit of money to go to school than for you to end up without any money at retirement.
Paper Work Reduction
Rather than having, maintaining, and opening multiple accounts, you can just do it all in one account – your Roth. In addition, you will not need to pay extra account and transaction fees as they will be included in an already existent account.
Disadvantages of Using a Roth IRA Instead of a Coverdell ESA to Save for Your Kids’ College
If you have more than a couple of children, the Roth IRA might not leave you enough room (within the contribution limits) to contribute for your retirement and each of the kids.
Limited Tax and Penalty Free Withdrawals
You will need to do the math and see if there is a likelihood that your contributions will not be enough. If it comes to pulling out more than your contributions to pay for higher education, then you will pay penalties.
A Hybrid Approach: Coverdell ESA and Roth IRA to Fund Kids’ College
Several factors make the hybrid approach appeal to me:
- I’m not going to do all the saving through a Roth IRA because I’m not sure if the contributions will be enough to help with the school costs of all three of my kids.
- Because I have three kids, I’d rather have a gap somewhere in case one of my kids doesn’t got to school or gets a good scholarship. Partially funding two ESAs and then funding a third through my Roth IRA allows me to enjoy the best of both worlds.
- I don’t really feel like opening and maintaining another account for my third child. If there is already a good savings vehicle in place, (my Roth IRA) why go to the effort to open something new that will be even more restrictive than what I have in place?
Our family goal is to help make the necessary preparations so our kids can graduate college with little or no student loans.
Before I go ahead with this plan, I want some feedback from my readers – does the Roth IRA sound like a good way to save for your kids’ college? Specifically, is using it for 1 out of 3 kids’ savings a good idea?