Posted by Larry Hurt

Four Things to Keep in Mind when using an IRA for Tuition

Four Things to Keep in Mind when using an IRA for Tuition

A survey in 2015 by Sallie Mae revealed that more than 6% of parents took from their retirement account – 401(k) or IRA to pay college fees. Over the years, as the cost of tuition and school expenses is rising, parents and guardians are looking to a retirement account like the IRA account to pay for school fees.

If you, however, want to use an IRA account to pay for college or grad school tuition, there are some things you must note. We discuss them below:

Rules Guiding using an IRA for college or Grad Fees

When you withdraw from your IRA account without reaching age 59½, you will be subjected to a 10% penalty. This penalty, however, can be waived in some circumstances. The IRS allows you to withdraw from an IRA account for higher education expenses or down payment of a house without the fees.

The expenses, however, must be for you, your spouse, a child, or a grandchild. You can use the funds to pay for books and other qualified expenses without the penalty. According to the Department of Education, however, the student will have to be enrolled in the school more than half of the time.

You cannot use a Roth IRA and Traditional IRA the same Way for Education Expenses. 

Roth IRA is best and commonly used for qualified education expenses without the 10% early withdrawal penalty. When a parent or prospective grad student contributes up to $20,000, and it grew to $25,000, they can use the donated amount, $20,000 for tuition fees without incurring extra tax or penalty.

For you to avoid a penalty, however, you must have operated the Roth IRA for five years without withdrawal.

According to financial experts, you can also use money from a traditional IRA for college fees. The con here, however, is that the account is subjected to both federal and state tax. 

An IRA Might Affect Financial Aid

This is one of the problems of using a Roth IRA for college or grad school tuition fees. When students apply for need-based financial aid, they will have to include their asset and income info on the Free Application for Federal Student Aid (FAFSA.)

Many schools use FAFSA to determine the award. When you have money in any retirement account like Roth IRA or traditional IRA, this is classified as assets that cannot be evaluated on the FAFSA for financial aid.

When you withdraw from an IRA account, financial advisors reveal that they classify this as income in the coming year. BancWest, a San Francisco-based financial institution, however, advised that students can use money from an IRA when the student is in the final year. This is because the financial aid for the following year wills no longer count.

A 529 account is an option worth Considering 

A 529 account has some similarities with a Roth IRA account. Like a Roth IRA account, a 529 is also a tax-advantaged education saving account, which is tax-deferred and can be used to take care of college tuition.

As an example, contributing $6,000 per year to a Roth IRA account, for example, for ten years will give you up to $60,000 tax-free for college education expenses.

Whatever money you have in a Roth IRA will not be used in evaluating financial aid. When you withdraw from the IRA, it will affect whatever financial assistance available for the student the following year. 

The main disadvantage of picking a Roth IRA saving over a 529 college saving is that there is a contribution limit that the account holder is limited to. If you are less than 50 years as a contributor, you can only deposit $5,500 in your Roth IRA. This limit increases by $6,500 on getting to 50 years of age. 

Concluding Remarks 

We understand that in some cases, saving for college using Roth IRA could make sense. There are drawbacks when you use it as your main primary college saving means. 

This is why you are better off using the account for what it is meant for – retirement savings!

Larry Hurt
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