Author Topic: Saving for Tuition in an IRA?  (Read 3764 times)

Derrian

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Saving for Tuition in an IRA?
« on: February 28, 2015, 10:46:40 AM »
Hey everyone,

I'm hoping someone can check my logic here to make sure my plan checks out. I'm planning on working for a couple years (to save money and take out fewer loans) before starting medical school. Traditional wisdom says put the money in a savings account. However, I recently found a Vanguard Prime Money Market fund that preserves the value of what is contributed. I'm wondering if it would make sense to put money in an IRA instead of a savings account as my IRA contributions would be untaxed now, which would allow me to save more, and will be taxed at my income rate when I use the funds, which would most definitely be lower than my current rate of 25%. Are there any factors that I am missing? Thanks for your time!

Hey It's Me

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Re: Saving for Tuition in an IRA?
« Reply #1 on: February 28, 2015, 11:20:04 AM »
Commenting to follow.

Indexer

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Re: Saving for Tuition in an IRA?
« Reply #2 on: February 28, 2015, 12:08:08 PM »
In addition when they calculate whether you qualify for financial aid IRAs aren't included.  Some families will actually use Roth IRAs instead of 529s for college savings for this reason.

Using a traditional on the other hand isn't something I've heard of.  If your tax rate while in school + the 10% penalty(which you might be able to get around anyway) is less than your tax rate now I guess it makes sense. 

So I can support using the IRA.

However I don't agree on the investment choice.  The Vanguard Prime Money Markets earns 0.01% I believe.  If 100% preservation of capital is important to you I would at least look at opening the IRA with one of the banks that offers rates closer to 1%.  I think Ally and PenFed get brought up, I personally use Capital One 360.

If you are willing to fudge a little on 100% preservation of principle there are also some fairly conservative investment vehicles you could look at.  Short term bond funds can get you 1%+ rates, but the value might fluctuate a little(normally less than 5%).  A really conservative balanced fund might get you 3-5% long term returns, but in a crisis it might be down 10%.  I personally like VASIX and I use it as my emergency fund.  80% bonds and 20% stocks tends to have a better risk return trade off than 100% bonds, and in a 2008 style crash VASIX was down around 10.5% with little to no downside in less severe crashes(it was up during the tech bubble crash).  I can live with that level of fluctuation. 
« Last Edit: February 28, 2015, 12:17:34 PM by Indexer »

bzzzt

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Re: Saving for Tuition in an IRA?
« Reply #3 on: February 28, 2015, 12:35:02 PM »
I'm hoping someone can check my logic here to make sure my plan checks out. I'm planning on working for a couple years (to save money and take out fewer loans) before starting medical school. Traditional wisdom says put the money in a savings account. However, I recently found a Vanguard Prime Money Market fund that preserves the value of what is contributed. I'm wondering if it would make sense to put money in an IRA instead of a savings account as my IRA contributions would be untaxed now, which would allow me to save more, and will be taxed at my income rate when I use the funds, which would most definitely be lower than my current rate of 25%. Are there any factors that I am missing? Thanks for your time!

I'm not a financial planner, but this is my part of my plan for my son. I don't want to sock too much money away in a 529 account that can only be used for education should he want to follow in his dad's foot steps (tradesman). A tIRA lets me reduce my tax liability now while having a savings vehicle for his education, should he pursue one.


Gin1984

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Re: Saving for Tuition in an IRA?
« Reply #4 on: February 28, 2015, 12:35:57 PM »
In addition when they calculate whether you qualify for financial aid IRAs aren't included.  Some families will actually use Roth IRAs instead of 529s for college savings for this reason.

Using a traditional on the other hand isn't something I've heard of.  If your tax rate while in school + the 10% penalty(which you might be able to get around anyway) is less than your tax rate now I guess it makes sense. 

So I can support using the IRA.

However I don't agree on the investment choice.  The Vanguard Prime Money Markets earns 0.01% I believe.  If 100% preservation of capital is important to you I would at least look at opening the IRA with one of the banks that offers rates closer to 1%.  I think Ally and PenFed get brought up, I personally use Capital One 360.

If you are willing to fudge a little on 100% preservation of principle there are also some fairly conservative investment vehicles you could look at.  Short term bond funds can get you 1%+ rates, but the value might fluctuate a little(normally less than 5%).  A really conservative balanced fund might get you 3-5% long term returns, but in a crisis it might be down 10%.  I personally like VASIX and I use it as my emergency fund.  80% bonds and 20% stocks tends to have a better risk return trade off than 100% bonds, and in a 2008 style crash VASIX was down around 10.5% with little to no downside in less severe crashes(it was up during the tech bubble crash).  I can live with that level of fluctuation. 
You don't get the 10% penalty if you are removing it for higher education. 

Bracken_Joy

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Re: Saving for Tuition in an IRA?
« Reply #5 on: February 28, 2015, 09:13:08 PM »
Oh, totally following this. Never thought about the IRA's not counting for financial aid check... always figured on setting up a college specific account for my (future) kids. Interesting considerations.

fa

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Re: Saving for Tuition in an IRA?
« Reply #6 on: February 28, 2015, 10:12:29 PM »
There is a clever strategy you can use if you own your own business.  You can hire your kids and pay them exactly the maximum Roth IRA contribution per year.  They can lick envelopes for you etc.  Then they put the earnings in the Roth IRA, obviously not paying income tax because they earn too little.

If you let 5 years go by, you can remove the entire amount of the Roth for educational purposes, without ever paying a cent tax on it.  So this strategy works best for younger kids, but old enough to do some work for you.  They also learn working for a paycheck at a young age.  How sweet is that?  Plus, it sounds like the Roth IRA money may not count for eligibility to obtain financial aid.  It is as good as it gets.  If they don't go to school, then the Roth can be an early start for their own retirement.

Bracken_Joy

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Re: Saving for Tuition in an IRA?
« Reply #7 on: March 01, 2015, 09:08:27 AM »
What happens to the 529s if your kids don't go to college?

teen persuasion

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Re: Saving for Tuition in an IRA?
« Reply #8 on: March 01, 2015, 09:54:21 AM »
Ok, looking thru the FAFSA paper form (for what you report) and the FAFSA formulas (for how it affects things) I find that tIRA withdrawals will appear in your AGI (question 85), and Roth IRA withdrawals appear in the untaxed income (question 94) as an add-back to income.  IOW, they are invisible as ASSETS, but withdrawals are counted as income.

In practice, the first year you fill out the FAFSA these will probably not appear, since you won't withdraw until tuition bills arrive.  The second year, those previous year withdrawals will change the FAFSA calculations.  Some people try to pay from other sources the first few years, and then do the withdrawals only after the last FAFSA is filed mid-junior year.

Not to say that this is a bad plan, just run the numbers for all the years to see the effects, be willing to use different methods in different years, etc.  Keep your eyes open to changes in the FAFSA rules and especially the tables.  Those seem to shrink each year.  Explore the Simplified Needs Test and Auto EFC = 0 test, especially the conditions for qualification (file 1040A, etc.).

Gin1984

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Re: Saving for Tuition in an IRA?
« Reply #9 on: March 01, 2015, 06:03:03 PM »
There is a clever strategy you can use if you own your own business.  You can hire your kids and pay them exactly the maximum Roth IRA contribution per year.  They can lick envelopes for you etc.  Then they put the earnings in the Roth IRA, obviously not paying income tax because they earn too little.

If you let 5 years go by, you can remove the entire amount of the Roth for educational purposes, without ever paying a cent tax on it.  So this strategy works best for younger kids, but old enough to do some work for you.  They also learn working for a paycheck at a young age.  How sweet is that?  Plus, it sounds like the Roth IRA money may not count for eligibility to obtain financial aid.  It is as good as it gets.  If they don't go to school, then the Roth can be an early start for their own retirement.
You do have to pay FICA for them, as they do as well.