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Roth IRA for College Expenses

Following up a bit from yesterday’s post Roth IRA’s for Infants, I want to look more in depth at the benefits of using a Roth IRA to fund your child’s education. With my wife expecting our first child in late May/early June the question of how to start saving for college has been weighing heavily on my mind.

While Roth’s are typically thought of as retirement accounts, which is their main use and they are very good for that purpose, many people might not know that Roth’s can also be used for college expenses. How much of the Roth you ask? Under current tax law any of the contributions can be withdrawn tax and penalty free. In addition, the income from the investments can be withdrawn without the usual 10% penalty, although it is subject to normal withholding tax. See this article by Jeff Rose for more info about qualified IRA distributions.

One big benefit of the Roth is that it is not considered as an asset when determining financial aid for the student. That alone could be the difference between whether or not your son/daughter can get financial aid. Of course the money is considered once it has been withdrawn, but with proper planning and deferred loans you could wait until after your child graduates and then withdraw one lump sum to pay off the loans. Please don’t take my word on that though as I am just beginning my research and am not 100% how that would work. Check with a certified financial planner if you’re considering a move such as that.

Since I own my own business I could legally hire my daughter when she gets older, pay her $5000 a year and place all that money in a Roth IRA in her name. At the very least she would have all of the contributions at her disposal to pay off college loans after she graduates. And if she needed to she could also withdraw any of the income, which should all be qualified by this time, assuming she was willing to pay the normal withholding tax. As an added bonus the $5000 yearly salary would reduce the profits from the business, thereby lowering my tax bill.

Obviously the Roth by itself would not be enough to pay for her whole college education, but it could be a big help, especially the part about it not being considered an asset for financial aid determination. Combining the Roth with a Coverdell ESA, financial aid and a job (for my daughter) we would have some pretty high powered ammunition to fight through the costs of a college education.

I still need to investigate the ramifications of the possibility that she would study overseas, but overall I am starting to feel more comfortable about this aspect of my current financial plan. If anyone has experience with children going to school overseas and how that effects such things as Coverdell ESA’s and 529 plans I’d love to hear from you in the comments below.

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