- A Roth IRA is a great way to save for retirement
but did you know that there are certain qualified expenses
that you can use your Roth IRA
for without paying that 10% penalty
for withdrawing that money?
Well, you can do exactly that if you want to pay
for qualified higher education expenses.
Yes.
You can actually use Roth IRA money to pay for college.
Here is what you need to know in this video.
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Hey guys, It's Justine with the College Investor Investing
and Personal Finance for Millennials, Roth IRAs.
If you don't know, they are a hype of retirement plan
in which you can contribute up to $6,000 of money each year
with after tax dollars into an account.
Now that money continues to grow tax free,
and then when you withdraw from that account
during retirement you get to keep that money tax free.
So it's a great way to save for retirement
but also there are ways that you can withdraw
from that money early on before retirement
without paying a 10% penalty.
Now, one thing to note, there are some regulations
on withdrawals from Roth IRAs
and that is any withdrawals that you make from your Roth IRA
that come from your contributions,
you can actually do that without paying a penalty
or paying tax
because you've already made those contributions
with after tax dollars,
you don't have to pay taxes on that money again.
So you can do that at any time
without penalty or tax consequences.
Okay.
So we talked about the contributions,
but what about the earnings?
What happens there?
So if you withdraw the earnings on that Roth IRA
then you will incur tax consequences
or that early with penalty of 10%,
except there are a few exceptions
on how to avoid that penalty.
Okay.
So the exception to the 10% penalty
is death of the IRA owner, becoming permanently disabled,
a qualified first-time home purchase,
higher education expenses,
health insurance premiums after being unemployed,
unreimbursed medical expenses
over a certain percentage of your income, an IRS levy,
a qualified reservist distribution,
in case of a qualified emergency or disaster,
and up to $5,000 for a qualified birth
or adoption distribution.
So you can make withdrawals on earnings
and not incur that 10% penalty
if any of those following situations applies to you.
But you will pay taxes on those earnings
if they are withdrawn for those purposes.
Now, when it comes to paying for college,
and let's say that you are wanting to use money
from your Roth IRA to pay
for these higher education expenses,
let's go through that example.
Let's say that you've made $25,000
in contributions to your Roth IRA,
and it has now grown to $35,000.
So you had $10,000 in earnings.
You can withdraw the original $25,000 contribution
without paying any extra penalty or taxes on that money
since you already contributed that with after tax dollars.
Now you will incur taxes and pay taxes
on the $10,000 in earnings
that you made out of that account.
So if you're considering this as an option
to pay for college,
remember that any distributions
that you might take from a Roth IRA will impact your FAFSA.
The FAFSA is the Free Application for Federal Student Aid
and this application really dictates
how much qualifying student loans your student
or the person going to college is offered.
And so when you take those distributions from a Roth IRA,
that will be reported as income,
and actually could lower the amount
of federal aid that you might receive.
Okay, so there are two big drawbacks
when it comes to using a student's Roth IRA.
First of all, if you have a student
and you've opened up a Roth IRA can get a little tricky
to get money into that account.
Mainly because there's a lot of rules about earned income,
and it's hard to fund that when they are a child.
And then if you were ever to take money out of that account
that money counts as income for the child,
which then again affects the Federal Student Aid
that that child might receive.
Now, if you were taking money out of a parent's Roth IRA
the biggest drawback here,
aside from paying taxes on the earnings,
is that you are taking from your retirement.
And there's no takebacks,
especially when when we're talking
about if you're taking out this money
during your midlife years
or you're getting closer to that retirement age,
when you take money out of that account
you're therefore taking away any potential earnings
that money could have earned
by sitting in that account for, you know,
a couple more years.
And so I think that's the biggest drawback
and why you wouldn't want to use,
this would be like a last, last, last resort
of using funds to help pay for college.
There is no federal aid for retirement.
There's federal aid for college,
and so you may be better off using something
like a 529 plan or a Coverdell savings account
to help pay for college
and not depriving your student of those choices
that are available to them without taking away
from your retirement.
Federal student loans is something
that we all want to avoid.
And also we wanna make sure
that we avoid taking away from our future selves
from living a very full retirement
and really building up that wealth
through an investment account, like a Roth IRA.
Now, if you want more tips
on how to save for college effectively,
and more tips about Federal Student Aid,
be sure to check out all of our free resources
at thecollegeinvestor.com.
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