How to Use a Roth IRA to Save for College
Saving for college is a significant financial goal for many families. While 529 plans are a popular option, Roth Individual Retirement Accounts (IRAs) can be a more flexible alternative.
Here’s how to effectively use a Roth IRA to save for college expenses.
Can you use a Roth IRA to save for college?
A Roth IRA is a retirement savings account funded with after-tax dollars. The key benefit is that your investments grow tax-free, and qualified withdrawals during retirement are also tax-free. Unlike traditional IRAs, contributions to a Roth IRA are not tax-deductible, but you gain more flexibility when it comes to accessing your money.
Roth IRAs can be used to save for college, but there are specific rules and considerations to keep in mind. We'll cover them next.
Benefits of using a Roth IRA for college
Tax-free withdrawals
One significant advantage of a Roth IRA is that you can withdraw your contributions anytime without taxes or penalties. This makes it a flexible tool for covering college expenses. However, earnings withdrawals before age 59½ may incur taxes and penalties unless used for qualified education expenses.
Flexibility
Unlike 529 plans, which are strictly for education costs, Roth IRAs don’t have restrictions on how the funds are spent. If the money isn’t needed for college, it can stay in the account and continue to grow for retirement.
Considerations: contribution limits and penalties
Financial aid considerations
However, when you withdraw money from your IRA accounts, it is counted as income and can affect your Student Aid Index (SAI). This holds true even if you don't use that money for college expenses.
IRA contribution limits
In 2024, you can contribute up to $7,000 annually if you’re under 50 and $8,000 if you’re 50 or older. While these limits are lower than what’s allowed in many 529 plans, they still provide a meaningful way to save.
IRA income limits
Your eligibility to contribute to a Roth IRA depends on your income. According to the Internal Revenue Service, for the 2024 tax year, the Roth IRA income limits are as follows:
- Single Filers: If your Modified Adjusted Gross Income (MAGI) is less than $146,000, you can contribute the full amount to a Roth IRA. Contributions phase out between $146,000 and $161,000. You are not eligible to contribute if your MAGI is $161,000 or more.
- Married Filing Jointly: If your MAGI is less than $230,000, you can contribute the full amount. Contributions phase out between $230,000 and $240,000, and if your MAGI is $240,000 or more, you are not eligible to contribute.
Taxes and penalties
While you can withdraw contributions tax-free, taking out earnings before age 59½ usually triggers a 10% penalty and taxes. However, the penalty is waived if you use the funds for qualified education expenses (though taxes on the earnings still apply).
Roth IRA vs. a 529 Plan for college savings
Both Roth IRAs and 529 plans offer tax advantages but serve different purposes. Here’s a quick comparison:
- Contribution Limits: 529 plans often have much higher limits, with some states allowing lifetime contributions exceeding $500,000.
- Tax Benefits: Withdrawals from 529 plans for qualified education expenses are tax-free, and many states offer tax deductions or credits for contributions.
- Flexibility: Roth IRAs offer more flexibility since the funds don’t have to be used for education.
NEW: The SECURE 2.0 Act
The SECURE 2.0 Act, effective in 2024, allows families to roll over unused 529 plan funds into a Roth IRA under specific conditions. The lifetime rollover limit is $35,000, subject to annual Roth IRA contribution limits. The 529 account must also have been open for at least 15 years. This new rule provides an excellent safety net if you’re worried about overfunding a 529 plan.
Should you save for college with a Roth IRA?
Using a Roth IRA to save for college can be a wise option, especially if you value flexibility. It’s important to weigh factors like contribution limits, income eligibility, and potential impacts on financial aid. Of course, consulting a financial advisor can help you make the best decision for your family's situation.
As you move towards the time for college applications, it helps to assess the likelihood of your student being accepted into a school before using it as a decision point.
With Appily, students can know where they stand when applying to any college. We take into account their academic information —GPA and test scores —to give them an estimate of how likely they are to be admitted. We also give insights into a student’s target, reach, and likely schools to make college list-building easy.
Just click the button to create a free Appily account and calculate your chances.
