Top Reasons Why Using a Roth IRA for College Is a Terrible Idea

If you’re a parent or graduate student looking for ways to pay an upcoming college tuition bill, you might be wondering, “Can my Roth IRA be used for education expenses?”

Technically, you can use a Roth IRA for college. This route isn’t ideal considering Roth IRA withdrawal limitations, and the more beneficial alternatives, such as a 529 college savings plan.

Here’s what you need to know about using a Roth IRA for college.

Rules for using a Roth IRA for college

One of the most important aspects to understand about using a Roth IRA is that you can withdraw your own contributions (i.e. the money you’ve put in) at any time. It doesn’t matter what age you are or what the funds are ultimately used for. It’s your money that you’ve already paid taxes on, so it’s yours to use without triggering a tax penalty.

That said, the earnings portion (i.e. the account growth) of your Roth IRA distribution has strict rules that you need to know before taking any distributions.

Qualified distributions are tax-free and penalty-free

The Internal Revenue Service (IRS) allows for qualified distributions from your Roth IRA that are completely tax-free and penalty-free.

Qualified distributions are defined as distributions that are made at least five years after making your first contribution to your Roth IRA. Additionally, the distribution must be taken for one of the following reasons:

• You’re at least 59½ years of age.
• A physician determined that you’re totally and permanently disabled.
• The distribution is made to a beneficiary or your estate after your death.
• You’re buying, building or rebuilding your first home. Note there’s a $10,000 lifetime limit per individual.

If you take a non-qualified distribution on your Roth IRA, the IRS can impose a 10% early withdrawal tax penalty. Additionally, your non-qualified distribution is subject to normal income taxes.

However, there are some exceptions for early distributions to avoid the tax penalty.

For example, exceptions are available for unreimbursed medical expenses that exceed 7.5% of your adjusted gross income and for distributions that are less than your qualified higher education expenses.

Claiming an exception for higher education expenses

You can claim an exception for paid higher education expenses that were used for yourself, your spouse, your children (includes foster and adopted), or your grandchildren.

Qualified higher-education expenses include tuition and enrollment fees to an eligible education institution (e.g. any college or vocational school that’s eligible to participate in federal student aid programs). But they also include costs like:

• Room and board for students enrolled at least half-time.
• Books, supplies and related equipment.
• Special needs services incurred by or for a special needs student.

However, you might still owe the additional tax penalty depending on your adjusted qualified higher education expenses (AQEE).

Your AQEE is calculated by subtracting any tax-free educational assistance (e.g. Veterans’ benefits or tax-free part of Pell grants and scholarships) from your total qualified education expenses. IRS Publication 970 has detailed information and examples for understanding AQEE and how it affects the 10% additional tax.

If you take an early distribution from your Roth IRA, you should receive Form 1099-R. This form includes information to help you determine how much of your distribution is taxable and how much is subject to the 10% tax penalty. The taxable amount of the distribution is then reported on Form 1040, 1040-SR or 1040-NR, line 4b.

If you qualify for an exception for qualified higher education expenses, you must also file Form 5329 to show how much (if any) of your early distribution is subject to the 10% penalty tax.

Pros and cons of using a Roth IRA for college costs

In most cases, using your Roth IRA to pay for college isn’t a wise idea. To ensure that the disadvantages of using Roth IRA for college stick, let’s start with the cons associated with this strategy.

Cons

• By using your Roth IRA, you’re draining your retirement savings to pay for college. Unlike with higher education, there aren’t any loan programs or relief assistance (e.g. forgiveness for federal student loan debt) for retirement.
• You’ll pay ordinary income taxes on any withdrawal of Roth IRA account earnings (not contributions).
• Your (or your child’s) need-based financial aid might be reduced because Roth IRA distributions are treated as untaxed income on the Free Application for Federal Student Aid (FAFSA).

Pros

• Tax-free and penalty-free withdrawals of Roth IRA contributions and qualified distributions.
• Early distributions used for qualified higher education expenses receive an exception to the 10% early withdrawal penalty (but you’ll still have to pay income tax on the earnings portion).
• If your goal is using a Roth IRA to save for college, you’ll have more flexibility in terms of investment options compared to most 529 savings plans. You can also use the funds on any eligible individual, rather than being limited to one designated beneficiary.

Should I use my Roth IRA for college tuition and expenses?

The simple answer is no, you shouldn’t use your Roth IRA for college expenses. That’s tax-free money that’s compounding and growing your long-term wealth. We don’t advise taking it out before reaching retirement or using it toward education expenses.

Dipping into your retirement funds is often compared to using an oxygen mask on an airplane. Flight safety procedures always direct passengers to put on their own oxygen masks before assisting children or others.

But just as some people will panic and try to help others with their masks first, some families might still choose to use Roth IRA withdrawals for expenses other than retirement. So, it’s important to understand how taking early distributions from your Roth IRA can impact your finances in the short- and long-term.

If you choose to use your Roth IRA for college, limit your withdrawals to your Roth contributions only to avoid paying any income taxes or withdrawal penalties on the distribution. But understand that, in turn, eligibility for need-based financial aid might be impacted.