Utilizing Assets in an IRA for College Expenses

Families or individuals will sometimes wish to tap retirement assets in an Individual Retirement Account (or IRA) to pay for educational expenses.  This has become an even more attractive option recently, as the rules governing both traditional IRAs and Roth IRAs have been amended in the past several years to allow withdrawals for qualified higher education expenses. The tax treatment of the funds used to pay for college varies based upon whether the assets being used for college expenses are located in a Roth IRA vs. a traditional IRA, however.  

With a Roth IRA, the principal portion (the amount you put in) can be withdrawn tax-free and penalty-free at any time for any purpose.  A key benefit of Roth IRAs is that distributions are not taxed as earnings until the entire principal balance is withdrawn. That means you can take out as much as you put in, tax-free, to pay for college and withdraw the earnings portion tax-free when you turn 59 1/2.  

By way of example, imagine that you have $100,000 in a Roth IRA on your child’s first day of college, $65,000 of which is principal and $35,000 of which represents earnings over the period that you have been contributing to the Roth IRA.  You would be free to use that entire $65,000 towards college expenses before needing to worry about any tax consequences and then you would still have $35,000 remaining that could be used for retirement purposes.  Note, however, that any withdrawals that exceed the total contributions are attributable to earnings and will be taxable for those under age 59½.  Therefore, if you withdraw $75,000 of the $100,000 from the example above to pay for college expenses and you are under the age of 59 ½, then the $10,000 of earnings withdrawn would be taxed as ordinary income on the following year’s tax return.

In the event you choose to withdraw moneys from a traditional IRA to pay expenses associated with college, the full amount of the withdrawal will be taxed as ordinary income, assuming both that you are under 59 ½ and that all your contributions to the traditional IRA were made on a pre-tax basis.  To use the same example from above, imagine you have contributed $100,000 to a traditional IRA.  Whatever amount you take out of the IRA to pay for college expenses is taxable, no matter whether you take out $10 or the full $100,000 in the IRA.  Therefore, whatever amount you withdraw will be taxed as ordinary income on the following year’s tax return.

When it’s time to prepare your taxes, any amounts that you withdraw from a Roth or traditional IRA are required to be reported on Form 5329.

Tapping retirement assets to pay for college expenses can provide an alternative to taking out costly student loans or paying college expenses in cash.  Ensure, however, that you understand up front what the tax implications of making any distributions will be in order to avoid an unexpected, and most likely hefty, tax bill.  If you do intend to withdraw assets from a traditional IRA or amounts in excess of your contributions to a Roth IRA, then consider either making quarterly estimated tax payments or adjusting your withholding to account for these distributions.

Another consideration from a planning perspective is that the $5,500 (for those under 50) or $6,500 (for those over 50) IRA contribution limits apply, no matter whether you plan to use moneys in an IRA for retirement purposes or to pay for college expenses.  Therefore, if you decide you like the thought of using an IRA to save for college, make sure to factor the IRA contribution limits into your planning.  

Are you having problems repaying debt, with student or other loans or do you need help coming up with a savings or investment plan? I offer assistance in debt management, student loan and general personal finance issues, including advising on debt management, resolving student loan problems and saving and investing strategies.

 Are you having problems repaying debt, with student or other loans or do you need help coming up with a savings or investment plan?  I offer assistance in debt management, student loan and general personal finance issues, including advising on debt management, resolving student loan problems and saving and investing strategies.  Initial consultation is always free and then I can provide you with a detailed written proposal.  If interested please email me at insideconsumerfinance@gmail.com. 

Are you really saving money by buying things on sale?

Are we always saving when we buy things on sale?  This question occurred to me as I was walking through the grocery store the other day, when I found myself getting excited and grabbing things that were not on my list but were on sale.  

My wife had given me a fairly short list of items we truly needed: milk, bananas, veggies, apples, etc.  But as I was waking through the store I noticed my favorite cereal was buy one get one free, so I grabbed four of them even though I had two already at home. 

I also have done this in the past with clothes-I went to the mall or store needing to get a couple dress shirts for work and ended up walking out with dress shirts, a couple ties, some casual shorts, etc.  The dress shirts I absolutely needed because I had worn out or gotten irreversible stains on several of my older dress shirts.  The other clothes, although I have worn most of them multiple times, were not strictly necessary.  

From my experience, whether you are really saving money by buying something on sale completely depends on both the time value of money and whether you actually would have bought whatever was on sale at some point in the future anyway, i.e. whether it is a want or a need.  So in the case of me buying my favorite cereal, I had two boxes left when I bought the boxes so I did not need them at that point.  However, I saved $8.00 by buying them now versus me paying the regular $4.00 price if they had not been on sale.  I go through a box every 7-10 days so I would have gotten little to no return on that $8.00 if I had not bought the cereal.  

The clothes I bought probably don't fit the same analysis. Yes I have more clothes as a result of my purchases of those on sale products and I do use them, but the extra $100 or whatever I spent on them might have been better invested, where it could have grown at whatever percent per year you consider the liky growth rate over the  near and long term future. 

So, at the end of the day, whether you are really saving money probably depends on whether what you are buying on sale is a want versus a need.   

Have you had a similar experience where you tend to buy things on sale just because they are on sale?  Do you ever wonder if you are really saving saving money by buying things on sale?

Guest Post on My Personal Finance Journey Blog

I did a guest post on the My Personal Finance Journey Blog on resources for resolving issues with your student loans when you are having problems with your servicer.

Post is available here

Do you drive out of your way for cheaper gas?

In driving home yesterday and, as I unfortunately often tend to do, I was on the search for a gas station because I had let my tank run down far enough that the gas light was on.  Because I was close enough to running out of fuel that I was getting nervous, I just drove into the first station I saw without even looking at the price.  I ended up paying $2.89 per gallon and saw another station half a mile down the road offering gas at $2.73 per gallon.  I have a ten gallon tank and only had a gallon left, so I ended up leaving around $1.50 on the table by waiting until the very last moment to fill up.

I previously had this really negatively affect my wallet a month ago when I was returning a rental car to the airport.  I deliberately waited to fill up until right before I got to the rental car return at the airport.  By way of context, the average price here is between $2.80 and $2.90 depending on which part of the city you are in.  As you may or may not know, if you bring a rental car back and the tank is not full, they charge you a ludicrous price that is typically more than double the going rate for gas wherever you are.  In this case, it was $6.00.  

In any event, every single gas station within half a mile of the airport was selling gas for $3.99 a gallon and up.  So, by not filling up two exits before the airport, I cost myself more than $1.00 per gallon.  I of course had no way of knowing this, but it was a lesson to me to not wait until the last minute to fill up because there is nothing I hate more than having to pay more money than absolutely necessary for something.  

So what did I learn from this experience? I am going to start keeping my eyes peeled for a good price around the time my tank hits halfway empty so I am not stuck stopping anywhere with a pump just because I am about to run out of gas.  

You may think it's a waste of time and energy to worry about saving such a small amount but I would point out that it can add up.  Let's say that each of my wife and I need to fill up once a week.   I have a little car with a small tank but she has an SUV with a 25 gallon tank so we are looking at $6.00 per month or $96 annually for me and then $4.00 weekly, $16 monthly and $192 annually for her for a combined total of $288 for the two of us.  

I know that doesn't wow you as a huge amount that will change your life, but that is still more than $20 per month to spend or save as you wish.  

After that math, I am going to stop the next time I see a station with a cheap price.  

Do you research ahead of time where the cheapest gas around you is?   Do you recommend any particular apps or websites that you find to be particularly helpful?

Automatic Bill Payment: An Easy Way to Simplify Your Financial Life

In today's banking world, virtually every financial institution offers both auto pay and online bill pay, including the ability to have your bills automatically deducted from your bank account.  This is a very convenient option for staying on top of your bills, as you don't need to worry about remembering due dates or possibly missing a payment deadline and incurring late charges.  

I have virtually all my bills set up for autopay from my bank account and I have them synced to come out the day after we get paid.  (As a general practice my wife and I always keep two months or so of expenses in our checking account in order to make sure we never have issues with unintentionally over drafting).  

Our bank lets us set up automatic bill pay through the bank itself, but we elected to set up the autopay through each of the third parties themselves (cable company, power company, cell phone, student loans, even retirement accounts).  My thought was that the utility or other third party themselves would be in a better position than the bank to resolve any issues that might come up if there was some sort of payment glitch.  

As far as drawbacks, one of the main concerns I have heard with automatic bill pay is that a third party has access to your bank account, theoretically enabling it to withdraw at will and potentially cause you to be overdrawn and get you hit with overdraft fees.  I have not actually heard of anyone I know having issues with this but have read horror on several personal finance blogs about people who paid off their student loans only to have the servicer continue withdrawing money from their account even after the loans were completely paid off.  So, in my mind at least, the likelihood of this happening is fairly low.  The specific concern about connecting the auto payments to your bank account versus a credit card is that once the money leaves your bank account it is gone whereas with a credit card your own money has not actually gone put the door.  Having had to work to get some charges on my debit card reversed recently when it got stolen, I understand what a pain this can be.  

I have some of my recurring bills auto paid to my credit card, including a charity I give to monthly, but there is no real rhyme or reason to this.  I just set it up several years ago and never bothered to change it to auto pay from my bank account.  

Auto paying your bills is a great method for reducing the hassle of paper bills and wasting postage on sending in checks. I would strongly urge you to consider it if you are not currently using it.   

Do you pay all your bills automatically? What has your experience with this been?

Weekly email newsletter starting this week

Just a reminder I am starting a weekly email newsletter discussing personal finance issues and recent news and court cases which impact your wallet.  Please email me at insideconsumerfinance@gmail.com if you would like to be added to my email list (no spamming).