college

Diverting retirement cash to a 529 plan

Joseph HurleyQuestionDear College Money Guru,
My wife and I have more than $150,000 in Roth IRA contributions in addition to another $300,000 in retirement savings. We have zero in a 529 plan or other college savings.

With our first child five years from college, we are concerned that Roth contribution withdrawals may not be a good vehicle for college tuition as the withdrawals show up as income on parent's financial aid even though they're not taxable income. This may affect ability of our child to obtain student loans.

We are considering cutting back on our 401(k) investments (both are maxed out) and saving aggressively in a 529 plan.

Thoughts?
-- Neal

AnswerDear Neal,
If you told me you were 100 percent certain that you will be paying college costs in the future, my response to you would be to go ahead and redirect some of your retirement savings to a 529 plan. You'll lock in tax-free earnings without having to wait until age 59 1/2, as you will with your Roth IRA and 401(k). You may even be able to secure additional state tax benefits, depending on where you live and which 529 plan you choose.

Plus, as you point out, you would avoid the negative financial aid impact of withdrawing funds from a traditional or Roth IRA, realizing that the aid formula considers withdrawals to be income whether any portion of them appears as income on your personal income tax return. In contrast, tax-free withdrawals from a parent- or student-owned 529 plan are not reported on the financial aid application as income.

The problem is that you can never be 100 percent certain that your child will be attending post-secondary school, or that it will not be paid from other sources. For example, attendance at one of the U.S. service academies is free to students. You need to assess the risk that your 529 plan earnings may eventually be taxable and possibly subject to a 10 percent penalty.

Obviously, you will not want to forgo an employer match to your 401(k) plan. But beyond that, the decision on how to allocate available savings among different vehicles is not clear-cut and involves many variables. Since you appear to have a considerable amount of assets at stake, you would be well served in seeking the advice of a financial planner.

Bankrate's content, including the guidance of its advice-and-expert columns and this Web site, is intended only to assist you with financial decisions. The content is broad in scope and does not consider your personal financial situation. Bankrate recommends that you seek the advice of advisers who are fully aware of your individual circumstances before making any final decisions or implementing any financial strategy. Please remember that your use of this Web site is governed by Bankrate's Terms of Use.

Read more College Money Guru columns and more stories about college financing. To ask a question of the College Money Guru, go to the "Ask the Experts" page, and select "College Financing" as the topic.

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