This is a question that many parents and grandparents have to answer as the cost of college keeps going up. Read more in this blog.
A Roth individual retirement account (IRA) can help you save for retirement by letting you put money in and take money out without paying taxes. It can also be used to save money for things other than retirement, like paying for a loved one's college. But should college costs be paid for with a Roth IRA? This is a question that many parents and grandparents have to answer as the cost of college keeps going up.
A Roth IRA is a tax-advantaged retirement account that anyone who works can put money into (up to a certain limit). When you take money out of a Roth you can use that money to pay for anything. This includes paying for college for a child or someone else who is a beneficiary. There is no penalty if these funds are used to pay for college.
Before you start saving for college, you should ensure your finances are in good shape and have a plan for saving for retirement. Remember that you can borrow money for college, but it's not a good idea to use debt to pay for your retirement. Depending on how old you are, you can take out different amounts from your IRA to pay for college. Because the money in your Roth IRA belongs to one of two groups:
You don't have to pay taxes or penalties when you take money out of your IRA. Most of the time, you will have to pay a 10% early withdrawal penalty if you take the money out before you are 59 1/2 years old. The money you make will also have to be taxed. You won't have to pay the penalty if you use those early withdrawals to pay for qualified education costs. But you will have to pay taxes on your income. Both the money you put into a Roth IRA and the money you earn from it can be used to pay for college. If you are under 59 and a half, you should only take out your contributions to avoid paying income tax on early withdrawals of earnings.
A 529 plan is a specific savings program created to cover college costs. Compared to a Roth IRA, it is more frequently used for that reason.
A 529 plan is a specific education savings vehicle. Unlike a Roth IRA, it is designed to let you save more money for education. State governments or the company in charge of running the 529 plan determine the annual contributions. Above $16,000 in annual contributions in 2022, the federal gift tax might apply. Compared to a Roth IRA, this enables substantially higher annual contribution limits. As a result, you can increase your savings goals, receive higher interest rates, and have more money available for your student's college expenses.
The tax benefits of a 529 plan differ from those of a Roth IRA. Yet, it is also less adaptable. To avoid penalties, withdrawals from a 529 plan must be utilized for eligible educational costs. You must pay tax on the excess of your donations and profits over what the beneficiary actually requires for their schooling.
Speak with a tax professional at Vincere Tax to find out the best ways to avoid any tax penalties on your 529 Plan
There is more freedom when paying for education with a Roth IRA. But, employing it can deplete your retirement funds. You could not have enough money if you stop working as a result.
Opening 529 accounts for college savings initially frequently makes more sense for families that are on pace to reach their retirement goals. Nevertheless, adopting a Roth IRA can provide your savings more freedom. Your financial condition will determine which option is best for you. What other retirement savings accounts you have accessible also matters.
Consult a financial planner at Vincere Wealth Management if you're unsure of the type of savings plan you ought to use.
The most you can put in a Roth IRA each year is $6,000, or $7,000 if you are over 50. If you file as a single person, you can only contribute the full amount if your modified adjusted gross income is less than $122,000 (you can contribute up to $137,000 in parts). You can make the maximum contribution (up to $203,000 for a partial contribution) if you are married and filing jointly and your MAGI is less than $193,000. A "backdoor" conversion is a way for savers of any income level to switch from a Traditional IRA to a Roth IRA. This is a taxed event.
You can put up to $15,000 into each 529 account each year without having to pay federal gift tax. You can also "superfund" the account by making a contribution of up to $75,000 (or up to $150,000 for a married couple) and then telling the IRS that the contribution was made over a five-year period. There are no income limits for contributors.
Roth IRA assets and other qualified retirement accounts like traditional IRAs and 401(k)s are not taken into account at all when figuring out the expected family contribution, which is used to find out how much financial aid you can get. (A higher expected family contribution means less financial aid; the Free Application for Federal Student Aid is used to figure out the expected family contribution.)
But if you use money from a retirement account to pay for college, it will change your expected family contribution two years after you use the money. That's because the FAFSA form counts the whole withdrawal as income at a 20%-50% rate, even the tax-free return of contributions, which shows up as untaxed income. To lessen the effect, don't use a Roth IRA distribution to pay for college until the student has filled out the FAFSA for the second year of college.
When figuring out if a student is eligible for financial aid, 529 assets owned by the parent or the student are counted at a rate of 5.64 percent. Qualified withdrawals from a 529 account that is owned by a parent or a student are not taken into account. This means that they are not counted as income for the expected family contribution. One thing that could go wrong is when someone other than the student or parent owns the 529 account, like grandparents. In this case, the distribution will be counted on the FAFSA as untaxed income, which can be counted at a rate between 20% and 50%. To keep the effects to a minimum, don't use money from a 529 plan owned by grandparents to pay for college until the student has filled out the FAFSA for the second year of college.
In order to pay for higher education expenses, you may make as many withdrawals as necessary. If you've had your Roth IRA for less than five years and are younger than 59 1/2, you may still owe tax on the earnings you withdraw even if you use the money for qualified educational expenses.
No. No matter how long you've had the account, you can always access your money to use toward things like college tuition. To avoid paying taxes on those funds, anyone under age 59 and a half who can wait five years can do so.
Consult a financial planner at Vincere Wealth Management if you're unsure of the type of savings plan you should be using today! We would be happy to help make the college planning process as smooth sailing as possible.
As Managing Partner of Vincere Wealth, Josh assists clients in navigating financial challenges and making sound financial decisions. Having someone guide you in making sensible financial decisions today can have a substantial impact on your future financial wellbeing. Josh takes great pride in guiding customers through the complexities of taxes, real estate, businesses, employer stock and international financial planning.
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