While a Roth IRA is not meant for saving for college, you’re allowed to withdraw your Roth IRA funds to pay for qualified education expenses like tuition, books, supplies, equipment, and room and board.
- You can withdraw your contributions to your Roth IRA at any age without penalties or taxes.
- Withdrawals of earnings in your Roth IRA before your Roth IRA is at least 5 years old, and before you reach the age of 59½, are hit with an early distribution penalty of 10%, in addition to income taxes.
- Paying for college is considered a qualified education expense by the IRS. You can withdraw earnings without the 10% early distribution penalty, but you’ll still have to pay income taxes.
Yes, both your contributions and earnings from your Roth IRA account can used to pay for college without incurring taxes or penalties. The IRS lists college as a qualified education expense, meaning you can use your Roth IRA to pay for things like tuition, books, supplies, and equipment. However, a Roth IRA is designed for retirement savings, not college expenses. Dipping into your Roth IRA early might not be the best decision depending on your current financial situation and retirement goals. In this article, we’ll look at all the pros and cons of using your Roth IRA to pay for college expenses.
Can a Roth IRA be used for college?
While a Roth IRA can be used to pay for college, you may have to pay income taxes depending on which portion of your Roth IRA you withdraw from. You can withdraw your contributions with zero taxes or penalties, but withdrawals of earnings would be taxed as ordinary income.
The way a Roth IRA normally works
A Roth IRA lets you withdraw your contributions only at any time without any taxes or penalties. However, to withdraw your earnings from your account, you would need to wait until your Roth IRA is at least 5 years old (at least 5 years must have passed since your first contribution) and you must be at least 59½ years of age. Withdrawals of earnings before this period would be hit with a 10% early distribution penalty plus income tax.
- Contributions are money that you deposited into your Roth IRA. You can withdraw contributions at any age without taxes or penalties.
- Earnings are the interest (profits) that your contributions generated from investing the funds.
For example, if you contributed $10,000 to your Roth IRA over the years, and it grew to a balance of $30,000 from investments, you would be allowed to withdraw only up to $10,000 that you contributed to the account. This amount can be withdrawn at any age without taxes or penalties. The $20,000 in earnings would not be eligible for withdrawal until your Roth IRA is at least 5 years old, and you reach 59½ years of age.
Also read: The Pros and Cons of a Roth IRA
Using a Roth IRA for college
There are certain exceptions to the early distribution penalty where the IRS lets you withdraw your earnings from your account without any penalties even if you’re not yet eligible for regular qualified distributions.
Paying for college is included as one of these exceptions.
You still have to pay taxes on the withdrawal of earnings if you’re under 59½ years old and your Roth IRA is under 5 years old. But you won’t be hit with the 10% early distribution penalty.
What counts as a qualified education expense?
You can withdraw as much as you need to pay for qualified education expenses.
Qualified education expenses include:
- School supplies and equipment
- Room and board (if enrolled at least half-time)
Does it matter what school I go to?
Yes, you must be enrolled in a qualifying institution, which includes accredited public, non-profit, private, for-profit college, vocational school, or other post-secondary institution. The institution must also be eligible to participate in a US Department of Education student aid program.
What is a Roth IRA?
A Roth IRA is a retirement account for individuals. It can be opened at any age and anyone, even minors, can start making contributions as long as they have earned income. Contributions are made with after-tax income, the money in your account gets invested with tax-free compounding, and withdrawals in retirement are completely-tax free.
For 2023, you can contribute up to $6,500 into a Roth IRA if you’re under 50 years of age and up to $7,500 if you’re 50 years of age or older.
Unlike most retirement plans, a Roth IRA has no required minimum distributions (which would require that you start taking distributions from your account every year until emptied, once you turn 73 years old). With a Roth IRA, you can keep your money compounding tax-free as long as you’re alive. If you pass the account to your beneficiaries after you pass, they can also withdraw the money tax-free.
Also read: How Does a Roth IRA Grow Over Time?
Using a Roth IRA vs a traditional IRA for college payments
The main difference between a traditional IRA and Roth IRA
- A Roth IRA is funded with after-tax income (money you’ve already paid taxes on). You don’t get any tax breaks when you contribute to your account, but withdrawals in retirement are completely tax-free.
- A traditional IRA is funded with pre-tax income (money you haven’t paid taxes on yet). You get a tax deduction in the amount that you contribute, but withdrawals in retirement are taxed as ordinary income (based on your tax bracket and tax rates at the time of withdrawal).
A Roth IRA is better to pay for college because you can withdraw your contributions without any taxes or penalties. With a traditional IRA, all distributions (including contributions) would be subject to income taxes when you withdraw.
For example, your total contributions are $10,000 and your balance has grown to $30,000. You have $15,000 in education expenses that you want to pay with your Roth or traditional IRA.
- With a Roth IRA, you could withdraw $10,000 without any taxes since contributions can be withdrawn tax-free at any age. The $5,000 in earnings that you withdraw would be subject to income tax.
- With a traditional IRA, you would pay income tax on the entire $15,000 that you withdraw to pay for college expenses.
Pros and cons of using a Roth IRA to pay for college
The advantage of using a Roth IRA to pay for college is the ability to withdraw contributions from your account at any age without taxes or penalties. Doing so could prevent you having to take on student loans, which is debt that would have to be repaid with interest. In addition, you’re also given the ability to withdraw earnings from your account without the 10% early distribution penalty. You’ll still have to pay income taxes, but if you’re a young adult getting ready for college, you’ll likely be in a low tax bracket anyways.
The main disadvantage of using a Roth IRA to pay for college is that you’re eating into your retirement funds that are invested with tax-free compounding. Withdrawing from your Roth IRA has a bigger impact than just the dollar amount that you take out. It’s money that could otherwise be growing with compound interest.
Additionally, as we’ll get to in the next section, distributions from your Roth IRA count as income on the FAFSA, which could affect your eligibility for student aid.
How paying for college with a Roth IRA affects your student aid eligibility
The Free Application for Federal Student Aid (FAFSA) is an application used by all schools for awarding federal student aid. If you need financial aid to help pay for college, you’ll have to fill out a FAFSA.
In the FAFSA application, you’re required to report income and asset information, which is used to determine your financial need and how much you’re eligible to receive. The assets in your Roth IRA is normally exempt from being evaluated on the FAFSA. However, the problem with taking a withdrawal from your Roth IRA is that distributions from the account count as income and are reported on the FAFSA, and could affect how much you’re eligible to receive.