Saturday, December 8, 2012

Roth IRA: Education Expenses Can Be Paid From Roth IRA Penalty Free


Many parents struggle with how they are going to save for their kids' college expenses while saving for retirement at the same time. Roth IRAs are very flexible investment vehicles, making them a good choice for parents who are juggling saving for college and retirement.

As always there are some rules to follow when using your Roth IRA to pay for college expenses, so make sure you understand the rules before you take a withdrawal.

Roth contributions can be taken out at any time for any reason. This makes Roths not only a great vehicle to save for retirement, but also to save for college expenses. While I recommend that parents put their retirement goals ahead of college savings goals, it's nice to know that you can withdraw your contributions to be used for college expenses, without worrying about paying taxes or penalties.

If you need more money than you've contributed to your Roth account, you still have options. Normally, distributions taken from a Roth before you reach age 59 ½ are subject to taxes and a 10% penalty (on the earnings only). However, there is an exception for withdrawals that are taken to pay for college expenses.

The early withdrawal penalty is waived if you use the funds to pay for qualified higher education expenses for yourself, your spouse or your dependent children. Qualified higher education expenses include tuition, room and board, fees, books, supplies and equipment. Unfortunately, withdrawals taken to pay back student loans do not qualify (I wish!).

The ability to use your Roth account to pay for college expenses is a huge benefit. However, the withdrawals taken from the Roth could affect your eligibility for financial aid. The good news is that Roth IRAs are not counted as an asset for either the student or the parent in the financial aid formula. The bad news is that withdrawals from the Roth IRA are counted as income in the financial aid formula. So you'll need to weigh the pros and cons before dipping into your retirement accounts for education expenses.

In addition, if you take Roth withdrawals to pay for education expenses, it could disqualify you from other education tax incentives such as the Hope or Lifetime Learning credit.

Please note that while the early withdrawal penalty is waived for withdrawals that are used for education expenses, you will still need to pay taxes on any earnings withdrawn before you reach age 59 ½. This is true regardless of how long the account has been open.

Bottom line, Roths are very flexible investment vehicles, which makes them a great tool for saving for retirement and other financial goals such as education expenses. However, there are rules to follow, and just because you can take a Roth IRA withdrawal to pay for education expenses doesn't mean that's the best option for you. You should consult with a tax professional before taking any withdrawals to determine if that's the best strategy for you.

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