Say goodbye to debt, and hello to a degree. Saving for college is less of a headache when you don't have to depend solely on a 529 college savings plan, Coverdell ESA, or student loans to fund your education. There's a little-known exception written in between the pages of the tax code that allows you to pay for college expenses with a Roth IRA retirement account, and the best part is that you won't be penalized if the funds are not used for college.

Student debt graduate with cap and gown.

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The Roth IRA is more powerful than you think 

It's easy to put the Roth IRA in a box exclusively for retirement -- after all, it's an individual retirement account that allows you to contribute after-tax dollars, grow your money over time, and withdraw the earnings tax-free after you've reached 59 ½ and met the five-year rule. But there's so much more to the Roth IRA than it gets credit for -- using the account to pay for qualified education expenses without incurring a 10% early withdrawal penalty is an incredible benefit that few college savers know about. 

Typically, withdrawing money from a retirement account before you are eligible can be dicey -- the penalties and taxes can rack up, potentially delaying your retirement goals. But if you already have a healthy portfolio of investments in a workplace retirement plan, you don't have to feel guilty about turning to your Roth IRA to cover your or a loved one's college tab. It comes in handy when you have to pay for tuition, books, fees, and supplies -- all of which are considered qualified education expenses as long as they are required for enrollment.

Unfortunately, there's a limit to how much you can contribute to a Roth IRA annually, so if you don't start early and contribute consistently, you won't have enough funds to cover education expenses. For 2021, you can contribute up to $6,000 a year if you're under 50 ($7,000 for people 50 and up). Anyone can contribute to a Roth IRA as long as they have earned income for the year that falls below the income limit.

Forget about financial aid worries 

If you are applying for financial aid using the Free Application for Federal Student Aid (FAFSA), you are required to report the value of assets such as checking/savings account, 529 college savings plans, and Coverdell education savings. These can reduce the amount of need-based financial aid you qualify for. However, because the Roth IRA is a retirement account, it will not affect your financial aid -- as long as your school only reviews the FAFSA to assess your financial need.

Roth IRAs are filled with perks, but you should always proceed with caution and strategy when using one to fund education expenses. Although the Roth IRA is not included in assets, distributions are counted as income on the FAFSA, and income can be a greater barrier to financial aid than assets.

There's a way around the Roth IRA income dilemma: you can withdraw Roth IRA funds during the last two years of school so that it doesn't have an impact on financial aid. The FAFSA uses income from two years prior to determine your financial aid amount. If you are applying for financial aid for 2021 -2022, you will use 2019 tax returns, making 2020 tax returns irrelevant. The timing of the FAFSA income requirements can work in your favor.

More flexibility and less risk  

Unless you have a crystal ball guiding your decisions, there's no guaranteed way to determine if college is in you or your loved one's future. A Roth IRA allows you to eliminate a bit of the guesswork by having a back-up plan available for college expenses if needed -- or you can simply enjoy the funds during retirement. 

There are pros and cons to every type of account, but the Roth IRA has built-in benefits that makes it too good to pass over. Unbeknownst to many savers, you can always withdraw whatever you contribute to your Roth IRA account at any time without penalty or taxes -- no need to wait until 59 ½ to withdraw the amounts you put in. If you contributed $25,000 to your Roth IRA over a period of time, you can safely withdraw $15,000 without any repercussions. 

The Roth IRA education exception gives you the extra benefit of bypassing the 10% penalty for early withdrawal of earnings. As long as your distribution is not more than your qualified higher education expenses. All you have to do is pay taxes on the earnings portion of your withdrawal which may be a better deal than signing up for debt.