01 Jan Use a Roth or a HELOC for college bills?

Q. When I started my Roth IRA, I planned for it to be for retirement. But now I have large college bills coming for my two children. When the college savings run out, I can take from a HELOC or the Roth. I don’t want the kids to have large loans. What’s the best choice?
— Mom

A. We’re glad to see you’ve saved some for college, but we know it’s so hard to cover all tuition bills without borrowing.

We also understand why you don’t want to see the kids take on debt.

You see headlines all the time about how much of a burden student loan debt is to the younger generation, resulting in delaying the purchase of a home longer and longer because of the strain the monthly payments puts on their cash flow, said Peter O’Neill, a certified financial planner with Beacon Trust in Morristown.

But you need to balance your needs with your hopes for your children.

Here’s what you should consider as you make your decision.

Because of the new tax laws enacted in 2017 and the current interest rate environment, home equity lines of credit (HELOCs) are not as attractive as they used to be, O’Neill said.

That’s because the new tax law eliminates the interest deduction for HELOCs unless the money is used for capital improvements that would increase your property value.

Furthermore, he said, it is possible that your home may end up “under water” – this occurs when the balance of the mortgage owed on a home is higher than the value of the home – if the value of your home were to drop significantly due to market conditions or other non-controllable factors, he said.

“Lastly, interest rates on HELOCs are variable, which makes monthly payments unpredictable and potentially unmanageable should interest rates spike higher,” he said. “Most market forecasters would agree that interest rates are headed higher, which increases the cost of capital.”

Then there’s the Roth IRA option.

O’Neill said Roth IRAs are great retirement vehicles because you put in after-tax dollars that grow tax-free until the account is depleted.

Assuming you’ve had the Roth IRA for at least five years, these funds can be used tax-free for your children’s college tuition, O’Neill said.

“However, utilizing these funds for anything other than retirement could potentially derail your retirement plans and cause you to come up short in terms of meeting your own financial goals,” he said. “It is important to ensure your retirement goals remain on track, and are not compromised at the expense of utilizing these funds to pay for your children’s college costs.”

Remember – you can borrow for college but you can’t borrow for retirement.

To the extent that funds from a Roth IRA are used to help pay for education costs, it would likely make sense to segregate the funds needed for college expenses from the remaining funds that are presumably earmarked for retirement, he said.

That’s because the funds you’ll need sooner for college tuition should be invested more conservatively to avoid having to sell stock investments during times of market volatility, he said.

“Perhaps the funds that are needed over the next few years could be invested strategically into CDs or T-Bills, as these shorter-term low-risk investments currently have attractive yields in the 2 to 3 percent,” he said.

O’Neill recommends sitting down with a certified financial planner to model future cash flows and to develop a plan to strike the balance between assisting your children with college costs and ensuring that you aren’t compromising your retirement and other goals.

The advisor could also offer guidance on how you can structure the investments in your Roth IRA to coincide with the cash flow needs for college tuition expenses.

“Lastly, it would be helpful to talk through alternatives that your children may have in order to help fund college costs such as work-study programs and potential grants that may be available, coupled with having your child take on some level of student loan,” he said. “This approach may serve to take some pressure off of you, while providing the opportunity for your children to have some skin in the game, responsibility for these costs, and build their own credit.”

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