Using a Roth IRA to save for college

We all want the best for our children, including a good education, but we also want to retire comfortably when the time comes.

Faced with the choice of saving for retirement or saving for your kids’ college, which should you choose?

There is one approach that can help accomplish both: Contributing to a Roth IRA. Most people think of the Roth IRA as a way to save for retirement, but it can also be a way to help save for a child’s college education as well. When you withdraw money from a Roth IRA, contributions made directly to a Roth IRA are always withdrawn before any earnings.

Consider the following example. The parents of a 3-year-old daughter each contribute $6,000 (the current contribution limit under the age of 50) into a Roth IRA every year for the next 15 years. If each of their Roth IRA accounts were to earn an average annual return of 8 percent, their combined Roth IRA account values after 15 years would be worth approximately $352,000 of which $180,000 is comprised of contributions (the other $172,000 comes from earnings).

As a result, the parents can withdraw their combined $180,000 of contributions tax- and penalty-free from their Roth IRAs to pay for their daughter’s college expenses.

What if the parents wanted to withdraw some of the $172,000 in earnings to pay for those college expenses? Generally, if you withdraw any earnings from a Roth IRA before you reach age 59 1/2, you must pay taxes and a 10% penalty tax on the distribution however if the money is used to pay for qualified college expenses, the earnings can be withdrawn penalty-free (but not tax-free).

What if their daughter should decide that she isn’t interested in attending college, or she attends college and is awarded a full scholarship? By choosing to save in Roth IRAs, the parents can now keep the entire $352,000 of savings invested in their Roth IRA accounts to grow for their retirement.

Saving money in a Roth IRA provides some flexibility in your savings plans. As long as it’s been five years since your first contribution, you can always withdraw the contributions in your Roth IRA at any time, and any age, for any reason, penalty-free and tax-free. That said, everyone’s situation is different and you should consider all of your investment options with your financial advisor to decide what’s best for your particular financial situation.