1. Cedric D'Hue says

    Hi Craig,

    You raise some very interesting points regarding using a Roth IRA for college savings. I would like to raise some additional considerations. First, Proverbs 3:27-28 teaches us to not withhold good from those who deserve it. “27 Do not withhold good from those who deserve it, when it is in your power to act. 28 Do not say to your neighbor, “Come back later; I’ll give it tomorrow”— when you now have it with you.” Personally, I am concerned by our willingness to “hide” assets from those who provide us with benefits, the government, higher education, etc.

    Second, your child has to have earned income in order to contribute to a Roth IRA. If your child doesn’t have earned income, Roth IRA is not an option.

    Third, if you withdraw only contributions you are not investing, you are only setting money aside in a 0% interest account. If you withdraw gains, they you are hit with a 10% penalty and taxes.

    Finally, if my child was preparing to graduate with student loans and with contributions in a Roth IRA, I would definitely consider advising my child to withdraw only contributions from the Roth in order to pay off/down the student loan debt. The Roth IRA gains would continue to grow and I would rather have my child make payments to their Roth than to a lender.

    I hope this helps and I look forward to future comments.

    As always, this is a heady area and you should seek the advice of a competent financial professional.

    • says

      Thanks so much for your feedback.
      The “hiding” assets is a very good point – one that I thought of when I wrote the article. I agree that using the plan I laid out would be intentionally deceptive and thus would not be a wise moral or ethical move. I guess it is strange that I even included it, because as I wrote the strategy I knew it was not one that I could ethically use. Just something I read and passed along. Perhaps in the future I shouldn’t pass along strategies that are unethical! What was I thinking?
      If you saved with a Roth IRA those funds would not be considered as assets for the child’s first year of school simply because they are not included until withdrawn from your Roth – when you pay the first bill. At that point your financial aid would already be determined. If a person had a problem with this they could withdraw the money early in the summer before they even started making applications (but, they would have no idea how much would be qualified deductions because they would not know the total school bill). If a parent wants to let a child work through college to see what is left then this would provide a possible financial aid benefit.
      In this post, what I am suggestion is using my Roth IRA as a savings vehicle not opening one from my child. As you said, the child must have an income to make Roth contributions. Sorry that I did not make this point more clearly.
      On your third point, the Roth IRA will be gaining interest, but basically all I would be doing is saying I don’t want to take out the interest only the principle. Thus, funds in an education savings account and a Roth IRA would both earn the exact same amount of interest. For example, if I had $75,000 in contributions and $25,000 in gains when I pay for school I would just say I want this money to come out of the $75,000 portion of the $100,000.
      Again, sorry for not making it clearer that the intention is to use my Roth IRA to save for them. Instead of making contributions to their ESA I would make the same amount of contributions to my Roth IRA.

    • Debra says


      To your second point. No, you would not pay a penalty on either contributions or gains/earnings if you withdrew funds from your Roth IRA and had the Education exception (see IRS Form 5329 instructions for these exceptions to the 10% penalty).

      The 10% penalty is if you don’t have an exception.

      The tax is on earnings, but it is at your ordinary income tax rate, and does not have a penalty.

      There is no tax on contributions. You’ll figure that out on your Form 8606. They’ll want to know your cost basis and your sales price to figure out your earnings (and thus what you will be taxed on).

      To your first point, I don’t think Craig was trying to “hide” funds at all. The fact is that for many tax deductions and tax credits, an AGI (Adjusted Gross Income) and MAGI (Modified Adjusted Gross Income) is figured. Using your logic, the MAGI might “hide” some income in figuring some taxes. I don’t agree that it is “hiding” money.

      First off, the student aid is coming in most cases as loans – sometimes borderline predatory loans (but Congress has been looking at that).

      There are so many different ways that the state and federal government calculate “income” for different purposes. It’s not “hiding” anything. There are Christians in these legislatures and Congress and they have to figure out an equitable formula for everyone to follow.

      What experience do I have to say the above?

      I have tithed 10% of my gross income since 1991.

      I have read the bible through completely, 5 times.

      I have worked at a tax firm for a few years, doing taxes.

      I myself have a Roth IRA and have withdrawn from it the last 2 years to complete a Master’s degree. I was just inducted into the academic honor society of Phi Kappa Phi and, God willing, will graduate in a few weeks.

      The last 2 sentences are most important because not only have I done other people’s taxes, but I did my own taxes for the above situation.

      I think Craig’s recommendation of using a Roth IRA is spot on, and I have heard that recommendation before. I just happened upon this site while searching the Internet on this topic and was surprised that Craig’s advice is more tax-accurate than some tax professional’s advice has been.

      So, look at IRS Pub 970, IRS Form 8606, and IRS Form 5329 (and all accompanying instructions) and you’ll be just fine!

      I appreciate your heart, Cedric, but I don’t think that *legally* keeping every dollar I can from the government (Caesar) is wrong or is “hiding” money. The government says that we can not include certain amounts when applying for government loans. That’s fine.

      I can use that money for God’s purposes.

      BTW, our home doesn’t count either, so I am a big advocate of owning one’s home outright too. That doesn’t count against a person for student loans, Medicaid, VA benefits and a number of other benefits. Further, in my state, we have strong property rights. The reason that a person’s home isn’t counted against them – if they own it outright – in most cases is because the cost of providing services to a homeless person is far greater than any benefit we get by owning our home outright.

      Have NO DOUBT that the government is LOOKING AFTER ITSELF when it makes policies and laws that give citizens a break for saving for their own retirement or owning their home.

  2. Gholmes says

    Interesting scenerio, have been enjoying your posts as they make me think. For me I really want to teach my kids not to use debt as a tool.

    My other thought is what % of your income are you saving for retirement? We are using Dave Ramseys 15% as our bench mark and currently we wont hit the $10,000 either. I want to be a good steward and not hoard money when it could be used now nor do I want to get to end of life and be a burden when I had the opportunity to wisely save.

  3. says

    “Third, if you withdraw only contributions you are not investing, you are only setting money aside in a 0% interest account.”

    Cedric – I’m sorry, this doesn’t sound quite right. If my child will need $100K in 20 years (to keep math easy) and I choose this route, at 10%/yr return, I’d have $286K. $100K for school, $186K to stay in the account for retirement. The gains stay in the account.

    Craig, an interesting approach. So long as the investor doesn’t double count those funds. With a $16.5K 401(k) cap, most people can fund their retirement that way and have the Roth as you suggest. If they don’t have access to a 401(k), the IRA/Roth IRA may be all they’ll have.
    The concept of Roth as dual purpose account makes sense. Even as emergency fund. If no emergency comes up, the money generates tax-free gains, if it does, no harm done.

  4. Cedric D'Hue says

    Hi Joe,

    Please allow me to clarify. With a Roth IRA, you could only withdraw contributions without penalty in order to pay for college.

    You are correct. My analogy isn’t the same for gains. The gains from your contributions would still be in the Roth IRA. The gains in a Roth IRA would make the Roth IRA better than setting money in a 0% interest account. My analogy is the same for the contributions, because you couldn’t use the Roth IRA gains for college without penalty.

    If there are two options to save for college: (1) a Coverdale or 529 where my contributions produce gains and I can use both the contributions and gains to pay for college, or (2) a Roth IRA which would penalize me from withdrawing gains, (1) tends to provide more benefit than (2) based on some of these considerations.

    Thank you for the correction. By the way, I enjoy your Personal Finance by the Book blog.


    • says

      I just replied to your last comment and then saw this one.
      The biggest problem with the ESA or 529 is that they are not flexible if I don’t use the money for education. In my situation there is a good chance that my kids will not even go to school in the states (they are all Canadian and US citizens).
      If I plan to take $30,000 out for their schooling and put in $22,000 then it is all a wash if I take the money ($30,000) out of a Roth or ESA – as long as I have contributed more than $30,000 to the Roth.

  5. says

    I’ve been struggling with how to manage our kids college savings. I had considered this approach in an all or nothing sort of way and decided against it and opened an ESA for our oldest (2.5). But the more I thought about how saving for our second (newborn) I was having trouble. We are pretty much following the Dave plan and are putting 15% into Roths and will be a little short of the $10K cap. So it was bothering me that I might be putting money into an ESA, not knowing how it may be needed (or not needed) by my children, but not maximizing our Roths.

    This hybrid approach is the solution I needed. One ESA & max’d out Roths for our 2 kids. Thanks for the good write up.

    @JoeTaxpayer “The concept of Roth as dual purpose account makes sense. Even as emergency fund. If no emergency comes up, the money generates tax-free gains, if it does, no harm done.”

    Using as an EF, hadn’t thought about that at all, thanks for the idea.
    .-= LRGCHE´s last blog ..lrgche: Approaching single digits on email on a Fri morning now that’s progress people! Ready for the weekend, just wish it would be a warm one #fb =-.

    • says

      If your income increases you will probably need to go with an ESA in the future, but for now using the hybrid approach sounds like it will work well for you too.

  6. Cedric D'Hue says

    Hi Craig,

    Your responses make perfect sense. Your proposed strategy could work well for parents who have over-contributed to retirement savings. No use in building bigger retirement barns.

    Your second post regarding ESA and 529 plans as not flexible enough for your situation is very intriguging. I’m sorry I don’t quite follow the example though I am interested in discussing it further. I’ll send you an email.

  7. Muneer says

    You can withdraw money out of a Roth IRA for these below reasons without incurring a 10% penalty… which is a good piece of mind provided by roth ira plans.

    8 Exceptions that Eliminate the 10% Early Withdrawal Penalty

    There are 8 exceptions to the 10% early withdrawal penalty (i.e. withdrawals that are taken before the age of 59 and 1/2). They are for distributions that:

    i) Are taken because of the IRA owner’s disability

    ii) Are taken because of the IRA owner’s death

    iii) Are a series of loan repayments made over the life expectancy of the IRA investor

    iv) Are used to pay for unreimbursed medical expenses that exceed 7.5% of the adjusted gross income of the Roth IRA owner

    v) Are used to pay for medical insurance premiums if the IRA investor has been unemployed for more than 12 weeks

    vi) Are used to pay for the purchase of a principal residence (maximum of $10,000 can be withdrawn). Also, the IRA investor must not have previously owned a home within the last 24 months.

    vii) Are used to pay for higher education expenses of the IRA owner or eligible dependants/family

    viii) Are used to pay back taxes of an IRS levy placed against the IRA

    • Jeff says

      Just make sure to realize that the earnings portion is still taxable is withdrawn for one of those reasons even though the penalty is waived (as mentioned earlier). People tend to get excited and forget that part when they see they qualify for a waiver.

  8. Vasu says

    ROTH IRA gives unlimited options in investing while 529 plan typically has only 5 or 10 options. Recently, lots of those options have been losing money. Another important disadvantage in 529 plan is that you can change the investment option only once in a year. If the stock market starts crashing, you cannot do anything until the end of the year. By then, the invested amount might lose heavily. What is your advice?

    • says

      You are exactly right that the Roth gives you many more investing options because you maintain control over the entire portfolio. While I don’t time the market you are correct that you can remove funds at any time you wish. Flexibility is the biggest advantage of a Roth.

  9. Aileen says

    I hear more and more people are reluctant to open college savings accounts because tying your savings to the stock market proved risky. If your kid won’t go to college for another 10-15 years, who knows what will happen by then to the money that was put aside and then invested. How good or bad of an investment are the guaranteed payout types of plan offered today by many banks or private companies (e.g. Gerber Life college plan)? Maybe the interest rate isn’t too appealing but at least you can be certain of what amount you will withdraw when it’s time.

  10. says

    Hi Aileen,

    The guaranteed payout plans offered today by many banks and private companies, especially Gerber Life College Plan, are good, bad, and ugly all at the same time.

    Do you have a savings account tied to your car insurance? Do you have a savings account tied to your cell phone insurance? Do you have a savings account tied to your home insurance? I am going to assume not. Then, why would you want to have a savings account tied to a life insurance policy?

    Think about this for a moment. Gerber Life College plan is an endowment life insurance policy. You pay premiums for life insurance coverage and then a portion to your childs education account. They take that whole premium and place it in a growth mutual fund and hedge the risk of you dying in the next 10 – 20 years so they end up earning roughly 10%-20% percent return on your yearly premium. Then, they give you, on average, 1-5% gauranteed return on your funds. The only way your child will actually make out in the deal is if you die prematurely and their guardian invests the full death benefit for the remainder of time before they go to college.

    Second, the Gerber life college plan is only good for one child. If you have three children it is three premiums and three plans.

    If you can find a good Brokerage ROTH IRA account it would be a good idea to possibly save for your childrens education. But, a normal Roth IRA will earn the same amount of interest as the Gerber Life College Plan…1-5%.

    Sure, your child may get a scholarship, you might work at a colege and they get to go to school for free, maybe they get a partial scholarship. We just don’t know what will happen 10-20 years from now.

    What I do know is the rate of inflation, on average, for the next 10-20 years is going to be 4% roughly every year. Which means 40-80% increase in college costs from current prices. Average college cost in this country is $36,000 per year ($36,000*4 years = $144,000 for four years of school- principal balance). $144,000*1.80 = $259,200.

    Any guaranteed plan will give you a max of possibly $150,000 (Gerber Life College Plan). You will be able to pay about half of their education. That is good right? You helped them immensely.

    As for me, I would rather invest half the amount needed to invest in a guaranteed plan in the same vehicles they would be investing within (growth mutual funds) earn 6-12% myself, and have $200,000-$500,000 ready for if and when my children want to attend college. If they don’t attend college…more for me and my retirement account.

    If you have three children you will need an estimated $780,000 for all three childrens education needs (assuming they all go to college) 20 years from now. $50,000 per child will not even make a dent in their payments.

  11. mj says

    Could ROTH IRA be funded form UN-Earned (Gift money for one..).

    All I read is Roth account could be only be funded by EARNED money. Please correct if I am wrong. Thanks.

  12. Elle says

    I’m sorry, but I totally disagree that you’re “hiding” money when you keep your money in the Roth IRA. It’s completely legal, it’s MY money (that God has given me to steward, of course) until I decide what to do with it. Why should I allow MY assets to affect my child’s ability to get student loans–when they are in fact, still MY assets and not theirs? If I want to let my children get student loans, then give them the money from MY assets to pay it off after college, what business is that of the government, or anyone else for that matter??? It could reasonably be argued that this is good stewardship! As a matter of fact, the idea is brilliant and I intend to do just that, unless the rules change in the 10 years until my first child goes to college. Brilliant.

  13. Bart says

    I agree with you that it is not unethical. The formula does not count the money in retirement funds in the same way it does not count the value of a car that might be sold to pay for tuition. Maybe my moral compass is a little off, but the strategy is to maximize the formula. If you want to consider the intent, maybe the formula writers intended the retirement money to ‘count against you,’ but I don’t’ know since they didn’t put it in the formula.

    Don’t forget that there are 2 prongs to this discussion. The parent and the child IRA. While I can see some taking exception to using the Child approach, I think the Parent approach is pretty ‘clean.’ Assuming that you would not meet the Roth limits with your retirement allocation, funding the remainder of the limit instead of a college fund for potential use for college is reasonable to me.

  14. zeek says

    I tried to post a comment before but something messed up and maybe an hour later I was able to get your site to come back up.

    You said that your wife stays at home but you contribute 10K to your roth ira instead of the 5K limit. And I have read elsewhere and in the comments to contribute to a roth ira you have to have earned income. SO I have some questions because I asked my tax person and financial advisor and they both said we could only do this if we showed my wife earning income and she would have to pay taxes etc on her income also:

    1. Are you transfering some of your income to your wife to show that she has income?
    2. How long have you been contributing 10K to your roth ira?
    3. Do you have any more information on how a married couple with the husband only working can contribute 10k to his roth ira?
    4. Can you give me detailed instructions on how you set this up?

    Thanks for you time and help

    • Jeff says

      Sounds like you need a new advisor and tax person. Very surprising that even one of them would say that. Stay at home spouses are not penalized from making IRA contributions as long as the working spouse has enough earned income to cover both. You don’t have to do any income manipulation. Just set the accounts up and fund them. No issues.

  15. says

    Very nice post with some really good ideas. The bottom line is that the Roth gives you a higher level of control for changing and unknown circumstances which is always a good thing. Also from the counting of assets for aid eligibility perspective this is a better way to go.
    The only danger in all this is that retirement savings should be just that and since the ability to put away money for such needs is a one time yearly thing there is an opportunity cost here if the funds are not used for retirement.

  16. Merlinda says

    This is very interesting article. I have 525 funds for both of my children and this one open my eyes more.

  17. says

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