There are a lot of ways to look at funding college for your kids. There is the I-Paid-My-Way-and-Junior-Can-Too. There is the parental guilt trip of putting away any extra money and forgoing retirement savings so young Betty Sue can go to Harvard without lifting a financial finger. Most of us will fall somewhere in the middle either by financial constraints or desire for our kids to have some skin in the game on their education.
Then there is the how to save question. 529 college savings plans have a lot of benefits for taxes and estate planning. However, the money must be used for education and that restriction can worry parents who aren’t sure their kids will go to (or finish) college.
Another option is saving in a Roth IRA for college. Roth IRAs allow you to put $6,000/year in (much lower than the up to $300,000 that can go into many 529s in a year) a retirement account. This account does not offer any up-front tax deductions for contributions. The growth is tax-free as long as the account has been open for 5 years or until the owner is age 59.5, whichever is longer.
Why use a retirement account for college? One benefit of the Roth IRA is that your contributions can be taken out at any time without tax or penalty. It’s the growth that gets dinged if you do early withdrawals.
Imagine you put $6,000/year away in a Roth IRA for yourself for 18 years earning 6% on average. The account in 18 years would be worth $197,000. $108,000 of that would be your own contributions that could be withdrawn without tax or penalty.
This could be a nice start to tuition. Let’s say you were age 45 when you took the principal out of the Roth IRA for college. That would leave $89,000 in the account. If that money grew at 6% until your retirement at age 65, the account would be worth $285,000 with tax-free withdrawals.
If your child didn’t use the money for college, your $197,000 could keep on growing (using the same 6% as before, no additional contributions) to $631,000 over 20 years. Nice!
This won’t work for everyone. There are income limits to who can put money in a Roth IRA (see link: https://www.irs.gov/retirement-plans/amount-of-roth-ira-contributions-that-you-can-make-for-2021). However, it could be a nice compromise for those who would like to prepare for college, but don’t want to completely commit money on the whim of an 18-year-old’s decisions.
