Using a Roth IRA as a Retirement Plan-College Savings Hybrid

 In Advisers, College Savings, Expectations, Financial Planning, Investments, Retirement, Roth IRA

Should you save for retirement or for a child’s college education?  This can be a dilemma for many middle class people with limited funds who have an interest in saving for both. One way you can kinda do both at the same time, with one account, is by using a Roth IRA.  Here is how it works:

Assuming you can fund a Roth IRA (most middle class people can) in 2015, people under 50 can contribute $5,500 and if you are 50 or over you can contribute $6,500.  The benefit of a Roth IRA, as you might recall, is that the interest you earn can be taken out tax-free if you keep the funds in there until age 59 1/2 or 5 years, whichever is later.  This is a good thing. Start a Roth at a young age if you can.

One of the most important and unique features of the Roth is that you can access your contributions, any time, with no taxes or penalty.  Keep in mind that the money you put in was after-tax – you have already paid taxes on it.  So, the government does allow you to withdraw your contributions – no questions asked. Some people think this is a drawback to the Roth, but I think it is a good feature. And this is how you could use a Roth for both college and retirement savings.

As you save money for your retirement, or your future, in your Roth, and your child or children get older and closer to college, you could end up using your contributions to help pay for college expenses!  For example, let’s say for 18 years you put in $4,000 a year in your Roth and it has grown, with interest and earnings, to $139,000.  You could take out any amount up to the $72,000 with no penalty!

In this example, you would still have the interest in your account to be used in the future.  Also, if both spouses put in $4,000 a year for 18 years, then they would have a total of $144,000 to access for their children.  Got it?  Not bad.

With this approach you have flexibility and some discretion over what you want to do based upon how your life unfolds and how your needs and your values might change over the years.  It is a given that we all experience change and unexpected circumstances and having flexibility in your investments can help you better address your financial needs in the future.  While I generally believe it is better to save for your retirement than for college if you have to save for one or the other, this flexible investment could help you with both goals.

One other note is that the Roth can also work for people that have children later in life.  If you need to withdraw from your Roth IRA after 59 1/2 and the account has been open for more than 5 years, the withdrawal is tax-free.  It can be used for anything at that point.

By the way, I would recommend that you keep a simple spreadsheet of your contributions each year and any withdrawals that you make from your Roth. Ultimately, it is your responsibility to accurately report any distributions you take from your Roth IRA to the IRS.

What do you think?  Could this work for you?

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