5 tips on using an IRA to pay for Education

Originally By: WISERADVISOR
Summarized By: PV Financial Group

Paying for college has become more difficult in recent years, with rising tuition costs and inflation making it harder for families to save. While many people are familiar with options like 529 plans or regular savings accounts, Individual Retirement Accounts (IRAs) are another useful—and often overlooked—tool for covering college expenses.

This paper provides a clear and practical guide to using IRAs to help pay for higher education. It covers how they work, what rules apply, and what families should consider before using them.

Understanding IRA Withdrawals for Education

IRAs are designed for retirement, but they can also be used for qualified education expenses. Normally, taking money from an IRA before age 59½ results in a 10% early withdrawal penalty. However, the IRS makes exceptions for certain costs—including college expenses for yourself, your spouse, child, or grandchild.

To qualify for the exception:

• The student must be enrolled at least part-time at an eligible institution.
• The funds must be used for qualified expenses such as:
  • Tuition and fees
  • Books and supplies
  • Room and board (if the student(s) are enrolled at least half-time)

Even though the 10% penalty is waived, you may still owe income tax on the amount withdrawn—especially from a Traditional IRA. Also, your withdrawal cannot exceed the actual education costs.

Traditional IRA vs. Roth IRA: What’s the Difference?

Though both are types of retirement accounts, Traditional and Roth IRAs are taxed differently, and this affects how they work for education expenses:

• Traditional IRA: Funded with pre-tax dollars. Money grows tax-deferred, but withdrawals are taxed as income. If used for qualified education, the 10% early withdrawal penalty is waived, but regular income tax still applies.
• Roth IRA: Funded with after-tax dollars. Money grows tax-free, and qualified withdrawals are also tax-free. For the withdrawal to be completely tax-free, the account must be open for at least five years and the owner must be 59½ or older. If used earlier for education, the 10% penalty is waived, but income tax may apply to earnings.

Both can be used for education, but Roth IRAs offer more flexibility, especially if you start saving early.

Education IRAs: The Coverdell ESA

Another option is the Coverdell Education Savings Account (ESA)—sometimes called an “Education IRA.” This account is specifically designed for education savings and offers some tax advantages:

• Contributions grow tax deferred.
• Withdrawals are tax-free if used for qualified education expenses.
• You can contribute until the child turns 18.
• The funds can be used until the beneficiary turns 30.

Like IRAs, Coverdell ESA funds can cover tuition, fees, books, supplies, and room and board. However, contribution limits are low, and eligibility depends on income.

The FAFSA Impact: What to Watch Out For

One important thing to consider is how using IRA funds affects financial aid.

Even though retirement accounts aren’t counted as assets on the FAFSA form, withdrawals from IRAs are treated as income. This means they can reduce the amount of financial aid your child is eligible for.

Helpful tip: FAFSA looks at income from two years prior. So, if you withdraw money from your IRA two years before your child applies for aid, the impact may be smaller. Timing is key.

Families can still use IRA funds while applying for aid, but they should be aware that it could reduce their financial aid package.

Don’t Sacrifice Your Retirement

While IRAs can help with college costs, their primary purpose is to fund retirement. Contribution limits are relatively low, so using the same account for both goals can be risky. If you withdraw too much for education, you may not have enough saved for retirement.

It’s important to have a separate retirement plan and to start saving early. Supporting your child’s education is important—but so is protecting your financial future.

Conclusion

IRAs can be a smart and flexible way to help pay for college—if you understand the rules and plan carefully. Whether you choose a Traditional IRA, Roth IRA, or Coverdell ESA, each option has benefits and trade-offs. Families should consider tax consequences, financial aid impacts, and long-term retirement needs.

Before making decisions, it’s a good idea to speak with a financial advisor. With the right approach, IRAs can play a valuable role in your family’s education and retirement strategy.

Source: https://www.wiseradvisor.com/blog/education-planning/5-tips-on-using-an-ira-to-pay-for-education/

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