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College Students and The Roth IRA

Why is it wise for college students to opt for a Roth IRA?

Key Points
  • A Roth IRA can help save for retirement
  • Saving for the future should start as early as possible
  • College students need to save for the future as well

Roth IRA And Students

There are many financial reasons for young students to contribute to a Roth IRA. Young students belong to low tax brackets, and they have the time to focus on retirement at an early age. So, they should start retirement savings accounts with the right options and create wealth.

It’s true that the Roth IRA is tailored for retirement savings, but you can also use it to increase college savings. With this investment fund, students will have a fresh start toward their retirement savings.

Students can choose from any investment vehicles, such as bonds, stocks, cash, ETFs, real estate, and mutual funds. A student can expect an average annual ROI 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, Roth IRAs aren’t reported as assets on the Free Application for Federal Student Aid (FAFSA).

Read More: Traditional IRA vs. Self-Directed IRA

Students And Roth IRAs – A Wise Choice

The main thing to consider in a Roth IRA is how student distributions are taxed. Qualified distributions are 100% tax-free and have no 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 used to pay for qualified higher education costs. Qualified higher-education expenses may include the cost of tuition, fees, room and board, books, supplies, and special needs. The student receiving the distributions should be studying at a college or university and eligible for Title IV federal student aid.

Students should have a job and earn money 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. If you are a student under age 59 1/2, you should only withdraw your contributions to avoid income tax payments on early withdrawals from earnings.

Benefits of using a Roth IRA for college students

● They are flexible – Since there is no single designated beneficiary, the account can be used to help people pay for multiple students’ costs. You can withdraw contributions at any time.

● Parents can help – Parents have the option to open a custodial Roth IRA. Not all online brokerage firms or banks provide custodial IRAs, but Fidelity and Charles Schwab can help you.

● The growth isn’t taxable – As a student, you have to pay tax on the returns you earn. When you withdraw the money, you do not have to pay extra taxes since it is already taxed.

More investment choicesRoth IRAs will allow college students to select from a variety of investments, such as stocks, bonds, ETFs, mutual funds, CDs, REITs, and more.

● No penalty on withdrawals – If a student withdraws money early to make payments for qualified education expenses, he or she won’t have to pay the 10% early withdrawal penalty.

● Marital status counts – Roth IRA eligibility and deposit limits after college will be considered based on marital status and earned income status. For singles, income earned must be below $153,000, and for married couples, it is $228,000.

Sophia Bera, a CFP and founder of financial advisory firm Gen Y Planning, added -“If an emergency comes up, you can actually take out the money from your Roth IRA and use it for any purpose.“

What are the Roth IRA contribution limits?

You can contribute only earned income to a Roth IRA and there are annual limits. You may contribute to a Roth IRA only if your income is less than a specific amount. The maximum contribution for 2023 is $6,500. If you are 50 years old or more, the amount increases to $7,500. You can verify the latest limits with the IRS here.

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.

The Roth IRA is a wise option for college students. The money they are preserving for the future is still available if something unexpected happens while they are still in college. They can access the funds in the Roth IRA anytime.

Another advantage of a Roth IRA account is that when a student gets a job after graduation, the IRS allows up to $10,000 to be withdrawn from the Roth IRA towards his or her first home without charging penalties.

So, being a college student, if you can save a few hundred dollars a year, keep doing it without fail. You’ll see the results in the next four decades. Any Roth IRA is a great 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

Author Bio:

Lyle Solomon has considerable litigation experience as well as substantial hands-on knowledge and expertise in legal analysis and writing. Since 2003, he has been a member of the State Bar of California. In 1998, he graduated from the University of the Pacific’s McGeorge School of Law in Sacramento, California, and now serves as a principal attorney for the Oak View Law Group in Rocklin, California.


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