Sunday Morning Quick Hits # 6: Roth IRAs as a College Savings Strategy

College savings strategies are a reality in my household. My youngest is a sophomore in high school and my oldest is already in college. He is a freshman at the University of Illinois. If you read last week's Blog, that should not surprise you because the brainwashing started early ... he had to listen to me sing to him the Illini war chat while he was still in the womb.

Clients that work with Brian and me know that we are fans of 529 college savings plans, especially Michigan's (MESP) plan administered by TIAA-CREF. We advise clients to stay away from many other state sponsored plans that are broker-sold given higher costs and commissions that impede long term growth and performance. In any event, 529 plans should be the focal point of any saving for college strategy.

But many parents that are saving for their kid’s college are unaware the role a Roth IRA can play. It can have a double-duty purpose (i.e., retirement and college savings). Let me explain.

It’s possible for parents to save for both retirement and future college costs by contributing to Roth IRAs. If your retirement needs are more urgent than paying for college costs, the Roth IRA will serve as a welcome source of tax-free funds, once your reach age 59 ½. But if you are ahead of schedule in saving for retirement when your kids go to college, the contribution portion of the Roth IRA accounts can be withdrawn with no taxes or penalties whatsoever at any time, for any reason—including paying for higher education expenses.

What's more, Roth IRAs are a retirement asset of the parents that are not included in applications for financial aid. However, keep in mind that if you apply for need-based financial aid in the year after taking these withdrawals from the Roth IRA, the distributions may count as “untaxed income” in the financial aid formula, and may therefore reduce the aid awarded.