Using Your Roth IRA for College Savings

A Roth Individual Retirement Arrangement (IRA) is primarily a retirement account, offering tax-free growth and tax-free withdrawals in retirement. However, its flexible rules allow it to serve as a source of funds for other significant life events, such as funding higher education costs. Because direct contributions can be withdrawn at any time without taxes or penalties, some families use a Roth IRA to supplement dedicated college savings plans. Understanding the specific regulations governing contributions, withdrawals, and the potential impact on financial aid is necessary for anyone contemplating this strategy.

Roth IRA Contribution and Growth Rules

A Roth IRA is funded with after-tax dollars, meaning contributions are not tax-deductible in the year they are made. Once inside the account, any investment growth is tax-free, and qualified withdrawals during retirement are also tax-free. The Internal Revenue Service (IRS) sets annual limits on how much an individual can contribute.

For tax years 2024 and 2025, an individual can contribute up to $7,000. Those age 50 or older are permitted to make an additional “catch-up” contribution of $1,000, bringing their total possible contribution to $8,000 per year. Contributions for a specific tax year can be made up until the federal tax filing deadline of the following year.

Eligibility to contribute to a Roth IRA is dependent on your Modified Adjusted Gross Income (MAGI). For 2025, the ability for a single tax filer to contribute begins to phase out with a MAGI between $150,000 and $165,000. For those who are married and filing jointly, the phase-out range is between $236,000 and $246,000. If your MAGI falls within this range, you can only make a partial contribution, and if it exceeds the upper threshold, you cannot contribute for that year.

Accessing Roth IRA Funds for Educational Expenses

The IRS applies a specific ordering rule to Roth IRA withdrawals. The first dollars withdrawn are always considered a return of your direct contributions. Because you already paid tax on this money, you can withdraw your contributions at any time, for any reason, free of taxes and penalties.

After all contributions have been withdrawn, subsequent withdrawals come from investment earnings. Taking out earnings before age 59½ normally triggers income tax and a 10% penalty. However, an exception for Qualified Higher Education Expenses (QHEE) allows you to avoid the 10% penalty, though the withdrawn earnings are still subject to ordinary income tax.

The IRS defines QHEE as expenses required for enrollment or attendance at an eligible educational institution, which includes most accredited postsecondary schools. The expenses can be for the IRA owner, their spouse, child, or grandchild and include:

• Tuition
• Fees
• Books
• Supplies
• Equipment required for enrollment

Room and board also qualify if the student is enrolled at least half-time. The distribution must occur in the same tax year the expenses were paid. The penalty-free withdrawal amount cannot exceed the total QHEE for the year, minus any tax-free aid the student received, like Pell Grants or scholarships.

Tax Reporting for Educational Withdrawals

When you take a distribution from a Roth IRA, your financial institution will send you and the IRS a Form 1099-R. This form reports the gross distribution amount and will arrive by the end of January of the following year. Box 7 of Form 1099-R contains a code indicating the nature of the distribution.

If you are under age 59½, the custodian will use a code that indicates an early distribution, as they do not know how you used the funds. It is your responsibility to report the use of the funds for qualified education expenses to the IRS to avoid the 10% penalty on any earnings withdrawn.

To claim the higher education exception, you must file Form 5329 with your federal income tax return. On this form, you will report the early distribution and use exception code ’08’ for higher education. This notifies the IRS that the withdrawal of earnings is exempt from the 10% penalty, but you must still report the earnings as taxable income on your Form 1040.

Financial Aid Implications

The interaction between a Roth IRA and the Free Application for Federal Student Aid (FAFSA) is an important consideration. Under the FAFSA Simplification Act, the value of qualified retirement accounts like Roth IRAs is not reported as an asset. This means your account balance does not directly reduce a student’s eligibility for need-based financial aid.

The treatment of withdrawals is different and can have a significant impact. Any amount distributed from a Roth IRA, including both the tax-free return of contributions and taxable earnings, is counted as income on the FAFSA. This income is reported based on a “prior-prior year” system. For example, a withdrawal taken in 2024 will be reported as income on the 2026-2027 FAFSA.

A large withdrawal from a Roth IRA can increase the Student Aid Index (SAI). A higher SAI indicates lower financial need and can reduce eligibility for need-based aid like Pell Grants and subsidized loans. Even though the return of contributions is not taxed, it is considered untaxed income for FAFSA purposes and affects the financial need calculation.