Legal Blog

The Weekly Scenario: College Savings Plan

Question: Can a Roth IRA be a good way to accumulate savings for college? How does it compare to a 529 plan for college savings?

Answer: The more you can put away for college, the better off you will be when it comes time to pay tuition expenses. A Roth can be a very good way to save for college and has certain advantages over a 529 savings plan.

When reporting assets on the Financial Aid application (“FAFSA” form) most assets, including 529 plans, are included in the calculation. By contrast, Roth IRAs (and other retirement accounts) are not considered assets in the determination of a family’s EFC or expected family contribution. Moreover, there is no cap so that you might be able to accumulate significant sums in Roth IRA accounts and still qualify a child for student aid.

The primary purpose of contributing funds to a 529 plan is to be able to enjoy tax free growth of the earnings which will never be taxed so long as distributions are used for education purposes. But a Roth IRA can provide similar tax advantages.

  • If you are over 59 ½ at the time you take distributions from your Roth IRA, and you have had a Roth IRA for at least 5 years, then anything you take out of your Roth IRA will be 100% tax and penalty free. This includes the use of funds for education related expenses or anything else.
  • But even if you are not 59 ½ (or have not met the holding period) at the time education related expenses are needed, you may still be able to take funds out of the Roth tax and penalty free.
  • Roth IRA contributions can be distributed at any age and at any time (100% tax and penalty free). As an example, if you contribute $1,000 per year to a Roth for 10 years prior to your child going to college, at the worst, you can take $10,000 tax and penalty free from the Roth.
  • Amounts converted to a Roth IRA may also be able to be distributed tax and penalty free — even if you are under 59 ½, Roth IRA conversions can be withdrawn tax and penalty free so long as the conversion took place five years ago or longer.

For example, if you convert $50,000 to a Roth IRA and at age 45 need to take the $50,000 out in 7 years to pay tuition expenses, the entire amount will be tax and penalty free. If you wait until you are 59 ½, gains you earn on the $50,000 in the Roth will also be tax and penalty free.

Comment: While the Roth account is not reported on a FAFSA form, paying college tuition with a Roth IRA distribution could impact the aid you are eligible to receive. However if you were to have your child take out a loan to pay expenses you would likely be able to later use Roth IRA distributions to help pay off the debt without any impact.

As always, if you have any questions or would like to learn more, please let me know.

ABOUT STEVE SHANE

Steven E. Shane

Steve Shane provides strategic counseling to clients in need of estate administration, charitable giving and business continuity planning while minimizing estate, gift, and generation-skipping transfer tax exposure. He offers legal guidance to clients on asset protection and the proper disposition of assets in accordance with the client’s objectives, while employing tax planning techniques such as the use of irrevocable trusts, life insurance planning, lifetime gifts and charitable trust. He is also experienced with drafting documents for business planning, the incorporation and application for exemption for Private Foundations and the administration of decedents’ estates.

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