The Downsides of Saving for College with a Roth IRA

The Downsides of Saving for College with a Roth IRA

Last week we talked about the potential benefits of saving for college with a Roth IRA. Even though it’s supposed to be a retirement account, there are certain situations where putting your child’s college money into a Roth IRA can make a lot of sense.

But there are some downsides to that approach too, especially when compared to using a 529 plan, and today we’re going to talk about some of the biggest.

Here are some reasons why you should think twice before using a Roth IRA for your college savings.

Are you sacrificing retirement?

There’s a limit to the amount of money you can contribute to a Roth IRA. In 2014 and 2015 that limit is $5,500 per year. So any money you put into a Roth IRA that gets earmarked for college means you have less space available to save for your own retirement.

And that Roth IRA is pretty valuable for retirement. Assuming you keep the money in there until you reach age 59.5, all that money comes out 100% tax-free to use however you please. There’s no other account that lets you do that, unless your employer offers a Roth 401(k).

I’ve written before about why saving for college is actually a pretty low priority for me and my wife. One of the biggest reasons is that we think it’s much more important to save for retirement, and that’s simply because there are many ways to pay for college (loans, scholarships, work study, etc.) but there’s really only one way to fund our retirement. We simply have to save money or face the real possibility of not having enough money later in life.

If you’re fully on track for retirement without using a Roth IRA, then using it for college won’t hurt your retirement savings. But if not, you run the risk of using up valuable retirement space for something that could be done elsewhere.

Here’s a tool that can help you figure out whether you’re on track for retirement.

Flexibility can create confusion

One of the positives of saving for college with a Roth IRA is that if you don’t end up needing the money for college, you can just keep it in there and use it later for retirement.

But that flexibility can also create some confusion. Remember that while you can use that money for EITHER goal, you can’t actually use it for BOTH goals. It’s one or the other, and that needs to be factored into your long-term planning.

If you would like to use part of your Roth IRA for retirement and part for college, one way to remove the confusion is to open up two different Roth IRAs. That way it’s always clear which money is for which purpose.

Can hurt financial aid eligibility

For the first year of college, a Roth IRA will likely be better for financial aid purposes than something like a 529 plan. That’s because none of your Roth IRA assets will be considered as part of your Expected Family Contribution on the FAFSA application.

But if you withdraw money from your Roth IRA to pay for college expenses (or anything else for that matter), the full amount of that withdrawal will be considered income on the next year’s FAFSA application and that will hurt your financial aid eligibility for that year.

And yes, that even includes the part of your withdrawal that isn’t taxed (you’re allowed to withdraw up to the amount you have contributed without paying taxes).

There are some ways you can plan around this that are beyond the scope of this article, but it’s definitely something to watch out for.

Want more help getting your family on the right financial track? Check out my free ebook: The New Family Financial Road Map.

 

No state income tax deduction

One of the benefits of a 529 plan is that your state might allow a state income tax deduction for the amount of your contribution. Not all states offer this, and some states don’t even have an income tax to begin with, but for those that do it can be a big benefit.

You won’t get any deduction for contributing to a Roth IRA.

Earnings you withdraw will be taxed

With a Roth IRA, you are always allowed to withdraw up to the amount you have contributed without any tax or penalty (with some exceptions). So if you have contributed $20,000 and your account balance is now $30,000, you can withdraw up to $20,000 without owing any taxes.

But any amount you withdraw over what you have contributed will be taxed. So in this example, if you withdraw the full $30,000, you will have to pay taxes on $10,000 of it.*

This is in contrast to a 529 plan, where the money you withdraw is 100% tax-free as long as it’s used for college expenses. This is a big part of what often makes a 529 plan more attractive if you’re sure that the money will be used for college.

*There would normally be a 10% penalty on that $10,000 as well if you took the money out before age 59.5, but that penalty is forgiven if you use the money for college expenses.

Smaller contribution limits than a 529 plan

The most you can contribute to a Roth IRA in one year is $5,500 (for 2014 and 2015). If you include both parents it’s $11,000 per year. Those limits are the same no matter how many children you have, though there is a $1,000 additional allowance if you are over 50.

With a 529 plan, you can contribute up to $14,000 per child. If you include both parents, it’s actually $28,000 per year per child.

And if you want to get really crazy, the IRS will actually allow you to contribute up to 5x that amount to a 529 plan in a single year, with NO tax consequences. Which means that each parent can contribute up to $70,000 per year, per child. (Note that if you do this, any further contributions within the next 5 years may be subject to special taxes. This is an area where it can definitely pay to talk to a professional first.)

Simply put, a 529 plan allows you to save more for college than a Roth IRA.

Income restrictions

There are income restrictions that limit who is allowed to make contributions to a Roth IRA.You can see the limits here, but for married couples filing jointly it’s around $181,000 where you will start to be phased out.

There are no income restrictions with a 529 plan. Anyone can contribute no matter how much they make.

Not great for gift money

One of the ways my wife and I have started saving for college without making big contributions ourselves is by putting the gift money our kids receive into their 529 plans. We will likely stop doing this once they are old enough to make decisions about the money themselves, but for now it’s a nice way to start building those savings.

Family members are usually excited about this, since they like the idea of contributing to our boys’ future. But I don’t think they would be quite as excited if we were putting that money into a Roth IRA, where our kids wouldn’t actually have any claim to the money at all.

If you want to use your child’s gift money for college savings, an account that is specifically dedicated to that purpose, like a 529 plan or Coverdell ESA, might be a better way to go.

Should you save for college with a Roth IRA?

There’s no right answer here. A Roth IRA can be a great way to save for college in certain situations, but there are some real drawbacks that need to be considered.

In the end it all comes down to your goals and what’s important to you.

For those of you who are already on track for retirement without a Roth IRA and aren’t sure you want to fully commit your money to college, putting your college savings into a Roth IRA can be a nice way to save ahead while still giving yourself some flexibility.

But if you’re not fully on track for retirement, a Roth IRA might be better used for that goal first. And if you’re 100% sure you want the money to be used for college, a dedicated college savings account like a 529 plan can offer better tax benefits.

What do you think? Do you think the positives of using a Roth IRA for college savings outweigh the negatives? Why or why not?

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54 Comments... Read them below or add one of your own
  • Done by Forty November 4, 2014

    I think we’re leaning toward the 529 ourselves. Seems like a better fit, and allows us to take the “both” approach when deciding between contributing to an IRA or 529.

    • Matt Becker November 6, 2014

      The “both” approach is really ideal if you can swing it.

  • Mario November 4, 2014

    I think you’re right.

    That said, for me, it’s still a tough question. I suppose if I knew beyond a shadow of a doubt that I would spend $xx,000 over four years at time certain and I’m absolutely tied to spending that amount, then it would be too easy. At another extreme, if I had no debt and enough disposable income to max out an IRA, 401(k), and HSA first, and still had plenty left over, then in this situation too, it’d be a no-brainer.

    Given that kids can get scholarships, grants, or loans at a tax-deductible 3.4% — or just go to one of the dwindling number of schools inexpensive enough that they can be paid for by the child in between classes — I would probably err on the side of the flexibility of a Roth IRA — except for, as you mentioned, the kids’ gifts. Those would definitely head to a 529.

    • Matt Becker November 6, 2014

      I think either one can be a great choice, and in many chases I think it’s a good idea to err on the side of putting more into the Roth IRA if only because saving for retirement should generally be a bigger priority than save for college.

      The one thing I’ll say is that you mention you kids potentially getting scholarships or grants, and in those cases you would actually be able to withdraw those amounts from a 529 without the 10% penalty. The earnings would still be taxed, but avoiding the penalty would make it a lot less of a burden.

  • Andrew@LivingRichCheaply November 5, 2014

    We’re contributing to both a 529 and a Roth. We prioritize the Roth but unfortunately still not maxing out. We were going to increase contributions to both…but will once again prioritize increase contributions to the Roth over the 529. Once we’re maxing out the Roth then we increase our 529 contributions.

    • Matt Becker November 6, 2014

      We prioritized our Roths as well, but those are viewed as strictly for retirement. Since we were already maxing those out, going with a 529 for college savings was a pretty easy decision for us.

  • Mike November 17, 2014

    What are your thoughts on the ESA or Coverdale plan?

    • Matt Becker November 17, 2014

      Great question! I actually have a post on the Coverdell ESA going live tomorrow, so check back in! Bottom line: I think it’s a great option. Here’s the URL for the post, but it won’t be up until tomorrow morning: http://momanddadmoney.com/coverdell-esa/.

  • Joseph Hogue November 17, 2014

    Tons of detail here. Great post. There are some benefits for using a Roth for college savings but, as you point out, its not really meant for that and other plans like the 529 are more suitable.

    Our son is only 2 so we’ve got quite a bit of time left ourselves. Before having a kid, I was dead set against parents paying for kid’s college. I paid for my own with loans and a scholarship and I think it helps with financial responsibility. Of course, now that we’ve got a kid my thinking is different. We have a Upromise Barclay card that feeds into his 529 account.

  • Mack February 12, 2015

    I think this is a great subject, and one that I’m delving into deeper since a little girl came into my life recently. How certain are you that withdrawals of contributions to a Roth will harm financial aid eligibility. I really hope that you are wrong about that point and it won’t be considered income. Contributions to Roth IRA’s are always made from taxes income to begin with. The money is counted as income from the year that it’s earned, then taxed, then you’re free to put it into the Roth account. It wouldn’t make sense for you to have to report it as income again. If you are talking about a Traditional IRA, then I think you are correct since those contributions were never taxes as income to begin with.

    • Mack February 12, 2015

      Nevermind. I reread your post and saw that I misunderstood what you were saying. Withdrawal of contributions aren’t considered income for tax purposes, but they will need to be declared on the FAFSA, thus affecting your child’s financial aid eligibility. Feel free to delete my remarks since I don’t want to add any unnecessary confusion to a good write-up.

      • Matt Becker February 13, 2015

        No problem! I’m glad it got straightened out. And you’re exactly right here. Withdrawals of your Roth IRA contributions DO NOT count as income for tax purposes, but they DO count as income for FAFSA purposes. Our tax code can be incredibly confusing sometimes!

        • Keith February 26, 2015

          Quick add-on question. Within a normal college tuition (say $20K/yr for the sake of argument), would the second year increased FAFSA income calculation offset the calculation done by the FAFSA each year for owning a 529?

          Thanks!

          • Matt Becker February 27, 2015

            Hey Keith. Great question, and while I can’t give any definitive answer here, I will say that in general income counts much more against financial aid than than assets. Here’s a quick overview of what percentage of different types of assets/income count against financial aid: http://www.savingforcollege.com/financial_aid_basics/financial_aid_and_your_savings.php. Only 5.6% of assets inside a 529 plan count, while 22-47% of your Roth IRA withdrawals will count.

  • Carolyn B May 27, 2015

    Hi Matt! I came across your site while trying to figure out how traditional & Roth IRA affect EFC in FAFSA application. Our total income is not enough to cover twin girls in college therefore financial aid is greatly needed. We were fortunate enough to save out of pocket $11,000 for 2014 and placed it in a traditional IRA. The good: our adjusted gross income for tax year 2014 is lower and got a bigger tax refund. The bad: the $11,000 contribution is added to the adjusted gross income thus increasing the EFC (estimated family contribution) & decreasing financial aid. Could Roth IRA have been the better option? I have also read that converting Traditional IRA to Roth will cause a higher increase in EFC. I really need to start saving for retirement since I lost all of it 2 years ago but it looks like saving for retirement and needing financial aid for college does not mix. Any advice?

    • Matt Becker May 27, 2015

      Great question Carolyn! This stuff gets confusing quick, and I’ll be honest that I have to refresh myself on all the rules as well. So here is my understanding.

      Contributing to a Traditional IRA or any other retirement account doesn’t hurt your financial aid eligibility. It just doesn’t help it either. That is, even though 401(k) and Traditional IRA contributions reduce your income for tax purposes, they do not reduce your income for FAFSA purposes. So while your Traditional IRA contributions didn’t help you qualify for financial aid, they didn’t penalize you either. Your FAFSA income was exactly the same as it would have been if you hadn’t made the contribution.

      Contributing to a Roth IRA would not have changed this. Roth IRA contributions don’t reduce your income for tax purposes either, so again there would have been no difference.

      The good news is that any money you contribute to a retirement plan now will NOT be included in the FAFSA calculation next year. That is, the $11,000 that’s now in your Traditional IRA, plus any other money that is already there, will be excluded from the FAFSA calculation next year. So while it doesn’t help you this year, it will help you in future years. A Roth IRA and 401(k) work the same way.

      The bottom line is this: while saving for retirement doesn’t help you qualify for more financial aid in the year you save, it doesn’t hurt you either. So there’s no reason not to do it. And it will end up helping you in future years. So if you need to save for retirement, then by all means go ahead and do so.

      Hope that helps! If you have any more questions please feel free to email me any time at matt@momanddadmoney.com.

  • Robert June 11, 2015

    Hi Matt,

    Is it better to create a Roth IRA in my name or Roth IRA in a custodial account? Does it matter when needing financial for my two girls (age 13 and 15) for college?

    Also can we use a 529 for oversea schools, which hopefully we can afford vs. the USA rising costs?

    As of now I have $90K in IRA’s at age 54 and my wife has nothing at age 45?

    Robert

    • Matt Becker June 11, 2015

      Great questions Robert! On the Roth IRA, there’s never a one-size-fits-all answer but I would say that in most cases it would be best to have it in your name. The main reason is simply that it gives you the flexibility to use the money for retirement, which is key. Unless you’er fully on track for retirement savings with other sources, that’s probably the only reason that matters.

      For financial aid purposes, I’ll be honest that I’m not 100% sure on the rules off the top of my head, but I don’t think it would be counted as an asset either way BUT I would assumed that withdrawals from a custodial account would count as the child’s income rather than yours, which would then be included at a higher percentage for next year’s FAFSA. Again, that would argue in favor of having it in your name.

      Also keep in mind that you can only contribute to a custodial Roth IRA up to the amount of earned income your child actually has.

      Finally, you can use 529 funds for some overseas schools, but not all. Here’s a search tool that you can use to look up specific schools: http://www.savingforcollege.com/eligible_institutions/.

      Hope that helps! Let me know if you have any more questions.

  • Tim June 18, 2015

    I read recently in a book about saving for college that when colleges are deciding whether to provide aid in the form of grants (not loans) that one of the things they consider is whether the applicant’s parents have saved money for college. The colleges like to see that the parents have tried to save money for college. Theoretically, if the parents have saved money for college in a Roth IRA, that does not show up as college savings, in contrast to a 529 plan. Thus, it appears that someone who saves for college in a Roth IRA has actually not saved for college, and this, theoretically, could work against the student in terms of receiving grants. What are your thoughts and experience on this issue?

    • Matt Becker June 18, 2015

      Great question Tim, and I’ll be honest that I don’t have a specific answer for you. I haven’t heard this myself, but that doesn’t mean it isn’t true. I do believe that most need-based grants are based on FAFSA, so I believe the calculations would be the same there. But other types of grants may have different criteria and honestly it may differ by school.

      In general, I would approach things like this:

      1. Save for your own retirement first and foremost.
      2. Save for college in tax advantaged accounts, whether it’s a Roth IRA like I discuss here or a dedicated account like a 529 plan.
      3. Be aware of how financial aid works, but don’t make too many decisions based on it unless you’re only a year or so away. Most aid comes in the form of loans anyways, so saving somewhere is almost always a better option.

  • Dayna June 29, 2015

    Hello. I’m confused about you mentioning that a Roth IRA CANNOT be used for both education AND retirement. Does this mean if I contribute money to a ROTH and I make a withdrawal to pay for some educational expenses, the balance cannot be used for retirement? Thanks!

    • Matt Becker July 1, 2015

      Hi Dayna. Sorry for the confusion! What I mean by that is that you can’t use the same dollar for two purposes. But you can absolutely use some of the Roth money for college and some for retirement. I just wanted to caution people about double-counting the money in there, thinking that all of it is available for both goals.

  • Dayna June 29, 2015

    By the way…My husband and I are all set for retirement (or so we have been told by financial planners), so a ROTH IRA would be considered an “extra” for us. Our daughter starts college this fall and we did not realize or consider how expensive this would be. We have an eleven year old as well and want to make sure we are more prepared to help him get through at least the first year or two. I am still paying my own student loans and I don’t want my children to end up in tons of debt over their education. Any advice?

    • Matt Becker July 1, 2015

      If know that you want to use the money for college expenses, a 529 plan or Coverdell ESA provides better tax benefits that a Roth IRA does. So I would at least consider that option if your retirement is already set without the Roth.

      I also want to emphasize the point that any Roth IRA withdrawals will count as income for FAFSA purposes (even if not for tax purposes) and would therefore hurt financial aid eligibility the next year.

      With that said, there are some advantages to using a Roth IRA, especially if you want to keep the flexibility of using the money for retirement if you don’t end up needing it for college.

      Finally, whether it’s saving for retirement, paying off your own student loans, or whatever, in general I think it’s a good idea to take care of yourself before saving for your child’s college education. There are many options when it comes to paying for college but really only one when it comes to caring for yourself.

      Hope that helps! Let me know if there’s anything else I can help with, and good luck!

      • Dayna July 1, 2015

        Thanks for the clarification. Yes, we are trying to focus on repaying my student loans before trying to save for college for my 11 year old. I was trying to think of a way perhaps we could just have a small ROTH as a backup “savings” plan for current college costs or maybe my daughter’s last year of college (so we won’t worry about FAFSA. As it is, she doesn’t really qualify for anything so I’m not too concerned about that. Next question…Can I use money in a ROTH to pay off my student loans? Or is there a more creative way of saving money to do this (or just apply it monthly)? Thanks!

        • Matt Becker July 1, 2015

          Gotcha. For student loans it’s probably going to be best to just pay them off as the money is available rather than saving ahead. The sooner you make a payment, the more interest you’ll avoid.

  • Brian July 26, 2016

    Can I fund a Roth IRA and if my child decides to go to college then I roll some portion of the IRA into a 529 at that time? Then I use the 529 to pay for the college and therefore don’t jeopardize my potential financial aid?

    • Brian July 26, 2016

      Just to be more specific, I mean to withdraw my contribution amount from the Roth IRA. I believe I have the right to that, tax and penalty free. So then I take that money and create a 529 plan once it’s clear that my kid is going for higher education. I then keep the Roth IRA earnings as extra retirement money.

      I guess the drawback would be if I need to dip into the earnings of the IRA for higher education (say the contributions I made were not enough) then I will need to pay taxes on that. The 529 plan earnings do not get taxed when used for higher education.

      • Matt Becker July 27, 2016

        Good question Brian. Actually, the big drawback to that strategy is that your Roth IRA withdrawal would count as income, which counts much more harshly against financial aid than savings/investments do. That’s true even you’re only withdrawing your contribution, in which case it WOULD be counted as income for financial aid purposes even though it’s NOT counted as income for tax purposes.

        • Brian July 27, 2016

          Hi Matt, thanks. Yes I gathered that through this article. The plan was for the IRA withdraw to happen years before the kid went to college. It’s just that at this young age there’s no telling what path he will take. So I open an IRA and say around 13 it’s clear he wants to attend college. At that time I withdraw my IRA contributions and open a 529 plan with. So the withdraw with have no impact on financial aid since it’s well before the college years. I would want to create the 529 as soon as it’s clear so it has time to grow tax free. Obviously it wouldn’t grow as much as if I created it from the start, but there’s always that risk that college just isn’t for the kid. It was just a thought…

          • Matt Becker July 28, 2016

            Gotcha. Then yes, other than the points in the article and the one you mentioned about there not being as much time for tax-free growth, this seems like it would work. I haven’t actually encountered this strategy before so I can’t say for sure that there aren’t any additional pitfalls, but there are none that I can think of. Good luck!

  • Jerry August 4, 2016

    I thought you could withdraw earnings from a Roth IRA if the account has been open 5 years or more. Another question, what if you have a 401k that you use for your retirement, would it be a good plan to open a Roth IRA for education funds if you are not sure if your kid will go to college, and you did it before the age of 13 to cover the 5 year earnings rule?

    • Matt Becker August 5, 2016

      The rule you’re talking about Jerry concerns the ability to take “qualified withdrawals” in retirement. Basically, you have to wait 5 years from the date of your initial contribution before you’re allowed to withdraw the earnings tax-free, but even then you have to be age 59.5 or else there are taxes and penalties on the earnings (with some exceptions).

      As for your other question, there are a number of pros and cons to that strategy, which are laid out both in the article above and this one. It can be a good way to maintain some flexibility, but you need to be careful to avoid the potential pitfalls.

  • Marta January 22, 2017

    Hi Matt,
    Would it make sense to open the Roth IRA in the child’s name? This way my own IRA contribution limits wouldn’t be tied up and the child has her account for retirement.

    • Matt Becker January 24, 2017

      Yes, that’s certainly an option but there are a few things to consider. First, when it’s in your child’s name it’s your child’s money to use. So you won’t necessarily be able to decide to use it for college yourself, as opposed to money that’s in your Roth IRA that you have full control over. Second, withdrawals would count as your child’s income, which would be an even bigger hit against financial aid. Third, your child must have earned income in order to contribute. You could still contribute to it from your own money, but you would only be allowed to contribute up to the amount of your child’s earned income.

      So it’s definitely an option, and can be an effective one, but there are limitations that are worth considering.

  • Susan January 24, 2017

    I’m a college professor and my children (ages 6 & 9) “may” have access to a tuition-exchange program at either my institution or an institution that is part of our consortium. I say may because the process is pretty competitive and I figure I should be realistic about future changes to this program. I’m also divorced. He contributes about $2,000 a year to each of the kids’ 529 accounts; however, I’m not confident that this will continue. I have chosen not to contribute to the 529 plans and, instead, contribute the maximum to a Roth IRA each year (I have about $123,000 in these accounts already). Because of the tuition-exchange possibility, I worry about limiting the use of these funds long term. To your point, I try to be careful about my thinking with these funds – EITHER not BOTH and, you’re right, this is difficult. I am also maxing out my 503-b (and get a 9% match from my employer) – so I’m not ignoring my own retirement. Based on my specific situation, I feel fairly confident that I’m doing the right thing in focusing my college savings as Roth money, instead of 529. If you see a pitfall I’m missing I’d love to hear your thoughts!

    • Matt Becker January 24, 2017

      Thanks for sharing your situation Susan! It sounds to me like your logic here is sound. The way you’re doing it, all of your money would be available to you for retirement if your children do qualify for this program, which is I’m guessing what you would want to happen. And at least for now, your children are also building money in college-specific accounts, so they’re really getting the best of both worlds.

  • C February 21, 2017

    Is there any benefit at all to saving via a Traditional IRA instead of a Roth IRA if both are available to me if it were to definitely be for child’s college?

    • Matt Becker February 21, 2017

      In most cases I don’t think so, simply because your income is likely to be higher when your child is college age than it is now, meaning that withdrawals from a Traditional IRA at that point will likely be taxed at a higher rate. Or at best the same rate. So unless you have a good reason to believe that your income will be significantly lower at that point, I think a Roth IRA is preferable.

  • Sheila March 30, 2017

    I am 48 and recently divorced. While married, my ex and I, were able to max out our 401Ks and contribute approximately $300,000 to a 529 account for our two children, ages 14 and 9. Since the divorce I am contributing 4 percent to my 401K. My company recently began offering a ROTH 401k and I am wondering if I wanted to contribute another $200-$300 a month to my children’s education, I am better off using that Roth 401K or a new 529 account. (I live in New Jersey which does not offer a tax deduction for 529 contributions and I believe I earn too much to contribute to a ROTH IRA.)

    • Matt Becker March 31, 2017

      Unfortunately, Roth 401(k)s are not as flexible as Roth IRAs, and therefore not as useful for college savings in particular. You can read more about the withdrawal rules here, but the biggest points are that:

      1) You must have had the Roth 401(k) for 5 years before being able to withdraw money without penalty.
      2) Each withdrawal is a pro-rata share of contributions and earnings, unlike a Roth IRA where withdrawals are counted as coming 100% from contributions first.

      You still may be better off putting money into a 401(k) than a 529 (more on that here), but a Roth 401(k) is generally not a great place to put money you want to use for college.

  • Craig May 5, 2017

    I don’t understand why you say a Roth can be used for retirement or college, but not both. Can you explain that?

    • Matt Becker May 6, 2017

      What I meant to say is that each individual dollar can only be used for one or the other. Sometimes having a Roth IRA earmarked for both goals makes it feel like each dollar is available for both goals, which can make it feel like you’re more on track than you really are. I’m just trying to caution people against double-counting their money.

      To your point, it is absolutely possible to use some Roth IRA money for retirement and other Roth IRA money for college.

  • Shawn May 24, 2017

    Did you ever dive deeper into the ways around avoiding Roth Withdrawals from counting toward Income on FAFSA? I always figured the Roth was a great idea (assuming you don’t need that vehicle to hit retirement goals), because it is not counted on your initial FAFSA paperwork as income/assets.

    At the point, couldn’t you just take a loan and not have to pay interest on it until 6 months after graduation? Meaning, no need to withdraw “income” from Roth until after your child has graduated, then pay off full amount with withdrawal of Roth Contributions? Since the child is already graduated, there would be no need to report on any additional FAFSA forms..

    Maybe I am mixed up on how the payback occurs.

    • Matt Becker May 30, 2017

      Good question Shawn. You may be able to use this strategy with subsidized student loans, but those are generally pretty limited in terms of the amount you can get. Most loans are unsubsidized, meaning that the interest accrues while you’re in school, even though you don’t have to pay it until you’re done with school, which would make this strategy a lot less attractive. Here’s a guide that explains more about the difference: Subsidized and Unsubsidized Loans.

      The best strategy I know of is simply to wait until the income would no longer matter because the FAFSA lookback period has passed. If you child isn’t going to graduate school, that would generally mean waiting until his or her Junior year, since the FAFSA looks back two years.

  • Shelley Sussman August 15, 2017

    I have two Roth IRAs and I’m planning on using some of the money from one or both of these accounts for my son’s educational expenses in his junior or senior year. (He starts college Fall 2017. I’m 56 years old and I won’t be 59.5 years old until his senior year.) Of course, I’d like to withdraw penalty free. One of your posts explained that a person must have had the Roth 401(k) for 5 years before being able to withdraw money without penalty. One of my Roth accounts (the one with less money in it) is over five years old and the other account (with less money in it) is not yet five years old.

    Can I withdraw penalty free from either account if only one of them is five years old? If not, can I move money from the “younger” account into the “older” account without penalty?

    Thanks!

    • Matt Becker August 16, 2017

      Good questions Shelley. The answer depends on the specifics of your situation, so I can’t say for sure. But here is a really good and detailed breakdown of the various rules and contingencies: Understanding The Two 5-Year Rules For Roth IRA Contributions And Conversions.

      If you’re just talking about Roth IRAs you’ve contributed to directly – and not money that either is currently in a Roth 401(k), has ever been in a Roth 401(k), or was converted from a Traditional IRA – then as long as one of your Roth IRAs has satisfied the 5 year rule, then all of them have satisfied the 5 year rule. It gets more complicated if you’re talking about money that was converted though, or if you’re adding Roth 401(k)s to the mix, and the article I linked to above gets into some of that.

  • Lori FM August 16, 2017

    As older-ish parents, we hope to keep contributing to our Roth IRAs. But, entering an expected 6-years of college expenses (2 kids) is just so hard to plan for! However, it seems that if we end up needing to take a distribution to help pay for college (or whatever) that amount will be counted as Income twice, possibly in the same year. Can that be correct?

    • Matt Becker August 16, 2017

      Well, FAFSA now looks back 2 years and if you’ve taken money out of your Roth IRA in that time period, it will be counted as income. It should only be counted once, though it may be counted for both children if that’s what you mean, assuming they’re filling out the FAFSA in the same year.

      I would definitely recommend speaking to a CPA or other financial professional who is familiar with these rules and can help guide you through your specific situation. It can be a little complicated to work through, especially when there are multiple children to consider.

      • Michelle October 3, 2017

        Lori has the same question as me.

        After-tax income that’s earned gets counted as income in the FAFSA year.

        When that “after-tax contribution” is later withdrawn from a Roth IRA for education, it’s counted as income again on the FAFSA even if it’s not taxable income.

        Seems like those same earned retirement dollars are being DOUBLE COUNTED as income. Why is that?

        • Matt Becker October 3, 2017

          To be completely honest Michelle, I’m not sure what happens if you make both the contribution and the withdrawal in the same year. But as long as they occur in separate years, I do not believe that they will be double counted since the FAFSA only looks at one year’s worth of data.

  • ben August 22, 2017

    So, I’m not seeing my idea in your article or in the comments. But I could have easily missed it.

    I am leaning towards a Roth IRA because of a couple of things –
    1) What if my child doesn’t end of going to school (bad idea)
    2) What if my child gets scholarships, i’d rather not be penalized because of that
    3) I will be 54 by time my child goes to college, so the idea is they will take loans out, build their credit and then when i turn 60, pay off they loans with the IRA or as much as i can at that point.

    Just my two cents. Would love any feedback on my thoughts.

    Thanks!

    • Matt Becker August 22, 2017

      All good thoughts Ben. In terms of scholarships, you are allowed to withdraw up to the amount of the scholarship from a 529 plan penalty-free, though the earnings will still be taxed. It’s not quite as advantageous as a Roth IRA in that situation, but it makes it a closer comparison.

      As for paying off your loans with your Roth IRA, there’s nothing I know of that would prevent you from doing that as long as you’re older than 59.5. You would just need to be careful about coordinating with FAFSA applications if you have younger children still in school.

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