01 Dec Should we use retirement accounts for college bills?

 Q. We have twins who are 10 years old, and we haven’t saved much for college yet. We do save for retirement, maxing out our 401(k) plans and then we put whatever we can in Roth IRAs each year. Should we start saving specifically for college, or can we use some of our retirement funds to pay for tuition?

A. You can save for college in a Roth IRA, but there are lots of reasons you shouldn’t — especially if you have other savings options.

For most people, the struggle between balancing the desire to pay for their children’s college and putting enough money away for retirement can be challenging, said Laura Mattia, a certified financial planner with Baron Financial Group in Fair Lawn. “Many parents are so anxious to give their children a head start in life that they are willing to risk their own retirement.”

In general, Mattia said, you may be thinking that all money is fungible and it shouldn’t matter how you save. But the benefits of earmarking specific funds as “retirement only” should not be overlooked, she said.

Before you rush to use the money that you saved for retirement, consider that there are alternative ways to finance college, but when it comes to financing retirement, your options are limited.

She said one advantage to using a Roth over a 529 Plan is that although the amount that you can save is limited, in the event that your child does not go to college, your invested funds in a Roth can be used for your retirement. With the 529 Plan, you could change the beneficiary on the account or you could take out the money, but you’d face a penalty and taxes.

Margaret O’Meara, a certified financial planner with the O’Meara Financial Group in Red Bank, also sees potential trouble if you use a retirement account for college savings. She prefers to see people save for the two goals separately.

“I have seen many parents in the best interest of their children jeopardize their ability to retire by paying for college with money that has been earmarked for retirement,” she said.

But as far as the rules go, the government does allow you to tap into your IRAs to fund college payments.

First, a traditional IRA.

“If the distributions from the IRA are used for college and the IRA owner’s age is under 59 1/2, the normal 10 percent penalty will not apply,” O’Meara said. “However, you will pay regular income tax on any deductible IRA contributions that you have made and withdraw to use for qualified higher education expenses.”

She said the 10 percent penalty is waived for qualified higher education expenses for you, your spouse, children or grandchildren, and you will not need to pay the withdrawn amount back.

To claim the 10 percent penalty waiver, O’Meara said, make sure with your Form 1040 you also file form 5329, which is where you would indicate the amount of college expenses you incurred during the year.

For a Roth IRA, she said, regular contributions can be withdrawn without tax or penalty for any purpose because they were after-tax contributions.

“Normally, earnings in a Roth IRA would be subject to a penalty if you take them out prior to age 59 1/2 if you have not had the account established for at least five years,” O’Meara said. “However, if the earnings are used for qualified education expenses, you will not have to pay this 10 percent penalty on the use of earnings.”

She said regular income tax will be due on the earnings that are withdrawn, and again, you will also need to complete the Form 5329.

Instead of messing with your IRAs, O’Meara recommends you consider a 529 Plan, which she calls one of the best ways to save for college.

“Contributions go into a 529 after tax and any earnings and contributions can be withdrawn free of federal tax,” she said.

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This story was first posted in December 2014.