Roth IRA vs. Education IRA

[Guest KariJo]

I would like to set up education IRAs for my small children but have recently been told that a Roth IRA might be better. I have read a little about the Roth IRA but I don't see anywhere where it says you can get distributions for educational expenses for children or if you can even set up a Roth IRA for minor children. Can someone help me out with this. What is better, Education IRA or Roth IRA? My children are 4 and 1 now.

[Michael Devault]

You're wise to start saving for your kids' college education NOW.

First of all, you can't set up a Roth IRA for children unless they have earned income. You can, however, set up a Roth IRA for yourself. Although it's not in the Internal Revenue Code, IRS Publication 590 says you can withdraw money from a Roth IRA for secondary education expenses for you, your spouse, or your children.

An educational IRA is OK, but the current contribution level of $500 per year is too low to do much good. You might look at some of the tax credits available, or see if your state has a qualified tuition program. They're nice if you have one available.

Bottom line: start saving now, on a regular basis, regardless of the vehicle. You'll be glad you did.

Hope this is of some help to you. Good luck!

[BPickerCPA]

Michael,

The withdrawals from the Roth for qualified education expenses will be PENALTY free, but not income tax free if you are under 59½.

Barry

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Barry Picker, CPA/PFS, CFP

New York, NY

[John G]

I have yet to see a really comprehensive article on the various options for saving for your childrens college costs. There are multiple approaches and each option has its advantages (tax shelter, simplicity, flexibility, etc) and weaknesses (max amount you can use, tax impact, restrictions on use, etc).

I agree that the first big negative of the education IRA is that the $500 annual max is just too small. Even if you start at birth, you may only end up accumulating enough to cover just one year of college expense. Note, assets in a childs name are counted more heavily in financial aide calculations.

The number of state type programs have grown so fast that it has been hard to keep up with all the variations. It is also tough to evaluate the merits of some of these state programs especially the "guarentees" which often have loopholes. You might want to contact Fidelity Investments because they have an interesting program that allows more $$ set aside, in a program that has a prescribed asset blend based upon the age of the child, sans "guarentees". Some of the other brokerages have considered putting out similiar plans... I invite readers to post any other referencs.

Another option: just buy some stocks and hold them until you cash them out when the bills arrive. Positives: you control the decisions, no limit on $$ you set aside, minimal tax impact (just dividends) until sale, assets can remain in your name and are marginable, if performance exceeds goals you keep the extra. Negatives: no shelter, long term cap gains taxes, no "guarentees" of performance, not professionally managed.

One of the issues that you should consider is if the child gets control of the funds at some point an may use them for (ahem) "non-college expenses". Or, what happens to the funds if the child does not go to college.

Good luck. My oldest starts this summer, so I am now in the write-a-check mode.