Why should college students open and contribute to a Roth IRA?

College Students and the Roth IRA

There are many reasons why young students should contribute to a Roth IRA. Young students are in low tax brackets and have time to focus on retirement early on. So they should start retirement accounts with the right options and create wealth. Having both a Roth IRA and a 529 plan can give flexibility for education expenses while also contributing to retirement savings.

While a Roth IRA is meant for retirement savings, it can also be used to save for college. With this investment fund, students will have a head start on their retirement savings.

In a Roth IRA students can invest in any investment vehicles such as bonds, stocks, cash, ETFs, real estate, and other alternative investments. A student can expect an average annual return of investment between 7% to 10% with an existing investment portfolio.

Like other qualified retirement plans such as 401(k), 403(b), Employee Stock Ownership (ESOP) and Simplified Employee Pension (SEP IRA), Roth IRAs aren’t reported as assets on the Free Application for Federal Student Aid (FAFSA). However withdrawals from a Roth IRA may be treated as income which can impact financial aid eligibility.

Read More: Traditional IRA vs. Self-Directed IRA

How Roth IRA works for College Expenses

A Roth IRA can be a great tool to save for college expenses. While its primarily meant for retirement savings, it can also be used to pay for qualified education expenses. To understand how a Roth IRA can be used for college expenses, you need to know the rules and regulations surrounding these accounts.

One of the biggest benefits of using a Roth IRA for college expenses is that the contributions can be withdrawn tax- and penalty-free at any time. This means the money you put into your Roth IRA can be accessed without any additional income tax or early withdrawal penalty, it’s a flexible option for college funding. However it’s important to note that the earnings portion of the account is subject to income tax and 10% penalty if withdrawn before age 59 ½ unless used for qualified education expenses. Qualified education expenses include tuition, fees, books, supplies and even room and board if the student is enrolled at least half-time.

By using a Roth IRA for college expenses, students and their families can benefit from tax-free growth of their investments and also have the flexibility to use the funds for both education and retirement savings. This dual-purpose feature makes the Roth IRA a great option for those who want to manage their financial future.

Students And Roth IRAs – A Smart Choice

The main thing to consider in a Roth IRA is how distributions are taxed. Qualified distributions are 100% tax free and no withdrawal penalty. A qualified distribution may include:

• Distributions taken at age 59 1/2 or older
• Withdrawals made after five years and the individual is 59 1/2 years old
• Withdrawals made due to total and permanent disability
• Withdrawals made to the beneficiary after the death of the individual
• Distributions up to $10,000 used to buy your first home

Non-qualified distributions from a Roth IRA won’t be taxable if it’s used to pay for qualified education expenses. The student receiving the distributions should be studying at a college or university and eligible for Title IV federal student aid. However if the earnings are withdrawn for non-qualified expenses they may be subject to income taxes and penalties.

Students should be employed to be eligible to open a Roth IRA account.

A student can pay his or her college expenses from both contributions and earnings from a Roth IRA. Assuming you are a college-age student, you should only withdraw your contributions to avoid additional income tax on early withdrawals from earnings. Annual contribution limits for a Roth IRA are based on your modified adjusted gross income (MAGI). If your MAGI exceeds certain thresholds you may be restricted from contributing to a Roth IRA.

Roth IRAs vs 529 Plans

When it comes to college savings two popular options are Roth IRAs and 529 plans. While both offer tax benefits there are some key differences to consider.

Roth IRAs are designed for retirement savings but can also be used for qualified education expenses. Contributions are made with after-tax dollars and the earnings grow tax free. Withdrawals are tax- and penalty-free if used for qualified education expenses, making Roth IRAs a flexible option for those who want to save for both retirement and college expenses.

On the other hand, 529 plans are designed specifically for education expenses. Contributions to 529 plans are not deductible from federal taxes but may be deductible from state taxes in some states. The earnings in a 529 plan grow tax-free and withdrawals are not taxable if used for qualified education expenses. This makes 529 plans a dedicated option for college savings with significant tax benefits.

One of the key differences between Roth IRAs and 529 plans is the contribution limit. Roth IRAs have an annual contribution limit of $7,000 in 2025 while 529 plans have much higher contribution limits, typically ranging from $235,000 to over $500,000 depending on the state. This higher contribution limit can be beneficial for families who plan to save large amounts for college costs.

In summary, while both Roth IRAs and 529 plans offer tax benefits and can be used to cover qualified education expenses, they serve different primary purposes and have different contribution limits. Choosing between the two will depend on your specific financial goals and needs.

Additional Roth IRA Benefits

● Roth IRAs are flexible – Since there is no single designated beneficiary the account can be used to help pay for multiple students’ expenses. Contributions can also be withdrawn at any time. Roth IRA accounts are particularly beneficial for young individuals saving for college as they allow early contributions and potential growth over time.

● Parents can help – Parents can open a custodial Roth IRA. Not all online brokerage firms or banks offer custodial IRAs but there are some that do.

● Growth isn’t taxable – When money is withdrawn from a Roth IRA you don’t have to pay extra taxes since it’s already taxed. However earnings withdrawn from a Roth IRA are considered taxable income which can impact financial aid eligibility and taxation during withdrawals.

● More investment options – Self-Directed Roth IRAs allow college students to choose from various investments such as real estate, precious metals and cryptos.

● Marital status counts – Roth IRA eligibility and deposit limits after college will be based on marital status and earned income status. For singles in 2025 income earned must be below $165,000. For married couples filing jointly, it’s $246,000.

What are the Roth IRA Annual Contribution Limits?

It’s important to understand you can contribute only earned income to a Roth IRA and there are annual maximum contribution limits. Additionally, you can contribute to a Roth IRA only if your income is below a specific amount designated by the IRS.

The maximum contribution for 2025 is $7,000. If you are 50 years old or older, the amount increases to $8,000.

Students can’t contribute scholarships or money received from their parents. Only money earned from a job can be contributed and reported to the IRS.

To Sum Up

As a college student, if you can save a few hundred dollars a year with a Roth IRA account, keep doing it without fail. This account will provide a long term benefit beyond just standard savings accounts as you will see the results over the ensuing decades. Students can use a Roth IRA to save for both college expenses and retirement, taking advantage of penalty-free withdrawals for educational purposes. Any Roth IRA is a good idea and there are also Self-Directed IRAs, with checkbook or custodian control, that can help you if you want to invest in your own goals.

Read More:

How Do Self-Directed IRAs Work?

Alternative IRA Investments

Beginner’s Guide to Alternative Investments