Inherited IRA As College Savings?

Jennifer's mother-in-law passed away. She left Jennifer and her husband some of her retirement money, and they want to use it for a college fund for their kids. Dave tells her how to go about making that happen.

QUESTION: Jennifer in Tennessee says her mother-in-law passed away. She left Jennifer and her husband some of her retirement money, and they want to use the money for a college fund for their kids. Dave tells her how to go about making that happen.

ANSWER: You would roll it to what’s called an inherited IRA, and you can take money out of that without paying a penalty, but you will pay the taxes as it comes out.

Maybe we don’t need to move it all out because I don’t think they’re probably going to need all of it for their college. But you could pull $10,000 a kid out and do two college funds that way or you could do an Education Savings Account—either one. And that’s only $2,000 a year per kid, and you pull it out as you need to fund that and pay the taxes as you go along.

I just don’t want to pay the taxes until we need to, unless you’re putting it in something that’s going to grow tax-free. If you properly do it with a college fund, it’ll do that . For instance, an Education Savings Account grows tax-free.

I probably would just do it—move it to the IRA knowing that you can pull it and it’ll grow—knowing you can pull it at any time only paying the taxes—but occasionally pull the $2,000 out per kid and just do that once a year. If you fund them with $2,000 a year from now until 18 years old in a good growth stock mutual fund in an Education Savings Account, that account’s going to be $100,000 each, give or take. That’s going to go a long, long way toward college, and yet you haven’t completely burned up the IRA at that point.