Q. I’ve heard that a Roth IRA is a good way to save for college. Is it? Does it shield the money from financial aid calculations?
A. Here’s the rundown on the Roth IRA.
It was named after the late Senator William Roth of Delaware, and it’s been around since The Tax Relief Act of 1997.
Most who are familiar with the Roth IRA know it as a vehicle for accumulating retirement savings. However, there are actually many good reasons to use a Roth IRA for college, said Cynthia Fusillo, a certified public accountant with Lassus Wherley in New Providence.
But first, a little primer on how the Roth actually works.
Unlike other retirement plans such as employer sponsored 401(k) plans and traditional IRAs, contributions to a Roth IRA are non-deductible, Fusillo said. This means you contribute with after-tax money. Eligibility includes income limitations.
For example, she said, a married couple filing jointly in 2018 can make direct Roth contributions if their Adjusted Gross Income (AGI) is below $189,000. This contribution is limited between $189,000 and $199,000 of AGI, and is completely disallowed when AGI exceeds $199,000.
“Withdrawals of your contributions, not earnings, may be taken at any time if the funds are used for qualified education expenses,” Fusillo said. “This does not apply to earnings in the account and those withdrawn earnings, used for education purposes, will be taxable if you are under the age of 59 ½.”
Normally distributions of earnings for an account less than five years in existence are also subject to early distribution penalties, she said, but when used for qualified education expenses, your distributed earnings will avoid those penalties.
Fusillo said there are financial aid benefits when using a Roth IRA as college savings.
“Retirement assets are not considered assets on the Free Application for Federal Student Aid (FAFSA), meaning your chances for financial aid eligibility are not impacted by owning a Roth,” she said. “By contrast, a percentage of 529 accounts are considered assets for FAFSA purposes.”
Leftover money in a Roth IRA that is not used for college can then be used for your retirement, she said.
“You do not have that flexibility with a conventional education account, such as a 529,” she said. “Leftover funds in a 529 are taxable when withdrawn if not used for education, and could be subject to a 10 percent penalty.”
One downside to using a Roth for college savings is that there are contribution limits. Specifically for 2018, they are $5,500 per taxpayer – or $6,500 for folks 50 and over – and you must have earned income in order to contribute, Fusillo said.
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