In the past, we’ve sung the praises of Roth IRAs. They have a number of benefits that make them an excellent choice for retirement savings, though many people wouldn’t consider them to be a good choice for education savings. However, we believe they have some benefits that should make them a consideration.

 

As we have stated, keep in mind we are not discussing all of the information available on Roth IRAs, so make sure you do your own research before deciding which plan to invest in. Also, be sure you understand all the distributions rules as well, especially in regards allowable expenses.

 

Advantages

  • Contributions into Roth IRAs are made after-tax, meaning you will not owe tax when the money is distributed. Also, Roth IRAs are first in, first out. This means that when you take a withdrawal, all of your original contributions come out first before any gains are withdrawn. So, if you make a partial withdrawal from a Roth IRA to fund education, it is unlikely you will have to pay any tax (unlike a Traditional IRA where the gains are withdrawn first). However, if you do withdraw gains and are under 59½ years of age, you will have to pay income tax on the gains, though if you use the money for qualifying education expenses, the usual 10% penalty on gains distributed will be waived. If you are over 59½ years of age (and the money has been in the account for 5 years or longer), the gains distributions will be completely tax free.
  • A Roth IRA’s primary function is for retirement savings. There is no obligation to use it for anything but that. So, if your potential student decides not to pursue postsecondary education, or doesn’t use all the funds, you will have that money for your future retirement, without having to deal with any tax issues.
  • Retirement accounts such as Roth IRAs are not counted as an asset in the calculation for federal financial aid.
  • Investment choices are incredibly flexible. You can invest wherever you want in whatever you want, allowing you to assess your own risk tolerance and the investment performance.

 

Disadvantages

  • Be very careful not to undercut your own retirement savings. While this is true for any type of education savings account, it is especially important to remember if you plan on using a retirement account. So, if you currently use only a Roth IRA to fund you future retirement, it wouldn’t be a good idea to use one for education savings. However, if you have another source of retirement funding, such as a 401(K), and you feel that you have sufficient savings already put away and could continue to fund another account for retirement, a Roth IRA could be a good choice for education.
  • Contributions to a Roth IRA have a number of different contribution rules you must abide by. You need to have earned income in order to contribute (for married couples only one spouse needs to have earned income for both to contribute). Also, there are income limitations on contributions (for 2011, Modified Adjusted Gross Income begins contributions phase out at $169,000 and the limit is $179,000 for married filing jointly, and contributions phase out begins a $107,000 and the limits is $122,000 for single). This rule obviously hampers high income earners from taking advantage of a Roth IRA.
  • Contributions are limited to $5,000 per spouse if you are under age 50, and $6,000 if you are over age 50. Since it is likely you can only contribute $10,000 annually, saving in a Roth IRA is not ideal for late savers, or for parents who have multiple children. $10,000 split between 3 or 4 children will likely not be sufficient in regards to education savings.
  • You can use the funds in a Roth IRA to pay for qualifying educational expenses for yourself, your spouse, your children, or your grandchildren. If you want to contribute to anyone else’s future education funding, it must be in another type of savings accounts.

 

Keep in mind that funding a Roth IRA in itself is by no means the only consideration that should be made while planning for college. Don’t simply max out your Roth IRA s every year and make no other plans. Many people tap their retirement accounts to pay for college without considering other options or the consequences to their own financial future. Please take the time to decide whether you should use a Roth IRA for education savings.

 

Next week we’ll discuss the last account types we’ll cover in this series, Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA).

Advertisements