As first-semester college kids head off for the ivied walls, parents are digging deep to cover the skyrocketing costs of a degree, and some are looking at nontraditional accounts like a Roth IRA as a method to fuel the financial madness.
It’s an out-of-the-box approach that’s doable, but financial advisors don’t suggest it without heaps of warnings. "The biggest con to using a parent’s Roth IRA to pay for their kid’s college is the fact that they are robbing from their own retirement,” says Dan Maga II, vice president at American College Funding, a college financial planning firm.
College costs are rising at a faster pace than inflation. Tuition and fees jumped 3.7% at private non-profit, four-year institutions to an average $31,231 in the 2014–15 school year, according to the College Board. For kids staying close to home, tuition and fees for full-time, in-state students at public four-year colleges and universities climbed 2.9%, to an average $9,139.
Families utilize different vehicles to stash cash for college, from standard savings accounts to 529 college-savings plans. But rising college costs are stretching some families’ budgets to the point where more financial help is needed. That’s where the Roth IRA steps in for some.
Parents can use a Roth IRA as both a retirement savings and a college savings tool. And in the right situation, there could be benefits to using savings inside a Roth IRA to help defray college costs.
How? Earnings in the Roth IRA grow tax deferred, a big plus when withdrawing. Second, savings inside a Roth IRA are not factored into the formula to determine the government's estimate on what a family can pay for college, known as the “expected family contribution.”
Here's How It Works
Parents under the age of 59 are eligible to withdraw from their Roth IRA contributions tax-free without a penalty. But keep close tabs on the numbers to stay within the rules. If your withdrawal exceeds your original contribution amount, the earnings may be subject to penalties and taxes. If you are under 59 1/2 and your Roth IRA has been open for more than five years, your earnings may not be subject to taxes if the withdrawal is used for qualified educational expenses—like your child’s college tuition, or even yours, for that matter.
Although that can unload a wall of financial worry for many parents, Maga says to think twice if you were counting on those dollars to help fund your retirement. “We always try to help parents avoid using their own retirement dollars to pay for their children’s college education," he says.
If you’re considering taking out a parent PLUS loan rather than dipping into a Roth IRA, the relatively high interest rate might set you back. The PLUS loan carries a 4.272% origination fee and a fixed interest rate of 6.84% for the 2015–16 school year, Maga says.
Yes, You Can Get Financial Aid
Don’t throw the towel in on financial aid, says Maga, who encourages parents to fill out the Free Application for Federal Student Aid (FAFSA) form. If the form isn't filed, loans and need-based grants won't even be on the table for students.
"The biggest mistake is when parents don’t apply for financial aid because they assume they won’t qualify,” he says. “Not only do some of these parents actually qualify for aid, but regardless of their financial situation, their student would be eligible for the federal student Stafford loan if a FAFSA was filed.”
Why is that important? “The Stafford loan is in the child’s name, guaranteed, and in today’s world, the cheapest money the student can borrow for college," Maga says.
Questions about Your IRA?
We’ve got the resources for retirement planning, including alternative uses of Individual Retirement Accounts.