05 Nov Pros and cons of a Roth IRA for college savings

Q. I don’t earn enough to save for retirement and college, and I know I’m supposed to put retirement first. What if I save in a Roth IRA instead of my 401(k), so I can take out the money for college?
— Need advice

A. Saving for retirement should come first. That’s because you can borrow money for college, but no one will ever lend you money to fund your retirement expenses.

Your proposed Roth IRA strategy has possibilities, but it isn’t a slam dunk.

Before you consider the Roth, you should make sure you’re taking advantage of your employer-sponsored 401(k) plan, at least to get employer matching funds, if offered.

This is “free money” that you shouldn’t miss out on, said Michael Cocco, a certified financial planner with AXA Advisors in Nutley.

But then, Cocco said, there may be some advantages to using a Roth IRA instead of a 401(k).

“Your contributions can be withdrawn at any time for any reason without tax or penalty, so you do not have to wait until age 59 ½ to access some of these funds, like you would in a 401(k),” Cocco said. “Your earnings in the Roth IRA can be accessed tax-free and penalty-free after age 59 ½, as long as the contributions have been in the Roth IRA for five years.”

He said Roth IRAs grow tax-free, so you won’t receive a 1099 with taxable dividends, interest, and capital gains each year.

Money saved in a Roth can be spent on anything, while funds saved in a 529 Plan must be used for qualified secondary education expenses. If not, the earnings can be taxed at ordinary income tax rates, plus a 10 percent penalty will be assessed.

Another advantage relates to your application for financial aid.

“Assets in your Roth IRA do not count as assets on your FAFSA student aid assessment, which can potentially allow you to qualify for more financial aid versus if your money saved was in a 529 plan,” Cocco said, but this strategy also has pitfalls. More on that in a moment.

This all may make the Roth strategy sound attractive, but there are some drawbacks.

To contribute to a Roth IRA, you must meet certain income limits, Cocco said. For 2015, you can’t contribute in full if you earn more than $183,000 in 2015.

“Even for families who are eligible to contribute, you are only allowed to put in $5,500 per person in 2015,” he said, adding that you can save an extra $1,000 if you are over age 50.

You didn’t say how old you or your college-bound child was. That may be important here, as the Roth earnings would not be accessible tax-free and penalty-free until after your age 59 ½, Cocco said. Depending on your age and your child’s age, it may not time out the way you want.

The strategy, longer term, could also cause you trouble with financial aid.

“If you draw on the Roth IRA for college costs, the following year, that money withdrawn from the Roth IRA would be treated as income in your financial aid calculation, which could seriously reduce the amount of aid qualified for versus the previous year,” Cocco said.

And here’s the big one: If you use your Roth money for college, there may not be enough left in your retirement accounts to fund your retirement.

“Yes, many of us want to help out our children as much as we can so they can graduate college without a bundle of debt, but sacrificing your retirement in spite of this may put an even larger financial and emotional burden on your children if they are forced to help support you throughout your retirement,” Cocco said.

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This story was first posted in November 2014.