Roth IRAs for College Savings

With college costs skyrocketing out of the reach of the average American family, parents need all of the advantages they can muster in order to save enough for their children’s pricey education. 529 college savings plans have been the method of choice since their introduction. However, an increasing number of parents are finding them to be less than ideal as a long-term savings vehicle. There’s typically a limited choice in plans. They can be laden with expensive fees, and, as more parents are finding out, not all kids are college material or they choose career paths that bypass a secondary education.

For those reasons, more parents are turning to Roth IRAs as a combined college and retirement savings account. Utilizing a Roth IRA allows parents to sock money away (on an after-tax basis) that will grow tax-free, and if their child goes on to college, the funds can be tapped to pay for eligible college expenses. Roth IRAs are limited to parents earning less than $178,000 (2013), or $112,000 as a single parent, who can contribute the maximum amount of $5,500 (2013). Parents over 50 can contribute $6,500. Funds grow tax-free, and they can be withdrawn tax-free.

Generally, funds that are withdrawn before age 59 ½ are penalized 10% by the IRS. However, when used for college expenses, parents can withdraw their contributions without paying any taxes or penalties. If the child is in college when one of the parents reaches age 59 ½, any of the funds can be tapped. There is also a rule that allows parents to take early withdrawals before age 59 ½ as long as the first withdrawal occurs more than five years after the first contribution.

What are the advantages of a Roth IRA?

• Plenty of choices of where to establish a plan and what you can invest in. You can create a portfolio of investments most suitable for your needs and risk profile.
• Lower costs. It can cost as low as $25 to establish a Roth IRA, and you can invest in low cost vehicles such as exchange-traded funds or no-load indexed mutual funds.
• Flexibility. college plans change, the funds can be used for retirement.
• Doesn’t count towards financial aid calculations.