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🎓 Are You Making This IRA Mistake? It Could Cost You Thousands in College Aid

🎓 Are You Making This IRA Mistake? It Could Cost You Thousands in College Aid

| October 23, 2025

🎓  Missing Records, Missing Aid

If you're a parent saving for college, you might be doing everything right: contributing to a Roth IRA, investing wisely, and planning ahead. But there's one silent mistake that could sabotage your financial aid eligibility and trigger unexpected taxes—not tracking your Roth IRA contributions.

🚨 The Mistake: Not Documenting Roth IRA Contributions

Roth IRAs are incredibly flexible. You can withdraw your contributions (not earnings) at any time, tax- and penalty-free—even for college expenses. But here’s the catch:

The IRS doesn’t maintain a centralized “contribution ledger” for your Roth IRA. They rely on your records and custodian reporting.

If you’ve switched custodians (moved to a new advisor or brokerage) or lost track of your contribution history, your new provider may not know how much of your balance is contributions vs. earnings. And if you withdraw funds without documentation:

  • The IRS may treat the withdrawal as earnings

  • You’ll owe ordinary income tax

  • You might trigger a 10% early withdrawal penalty

  • The withdrawal becomes reportable income, which can reduce FAFSA-based financial aid eligibility

💥 A Ruinous Example

Let’s say you’ve contributed $50,000 to your Roth IRA over 18 years. You withdraw $20,000 to help with your child’s college housing. But you’ve switched custodians twice and never tracked your contributions.

Without documentation, the IRS assumes that $20,000 came from earnings.

  • You pay income tax on the $20,000

  • You lose need-based aid because FAFSA sees a spike in income

  • You could miss out on grants, subsidized loans, or work-study eligibility

All of this could’ve been avoided with a simple spreadsheet or saved forms.

✅ How to Avoid the Trap

  • ☐ Track your contributions annually: Date, amount, and source

  • ☐ Save Form 5498: Sent by custodians each May, shows contributions

  • ☐ Request summaries before transferring accounts

  • ☐ Keep Form 8606 if you’ve made conversions or non-deductible contributions

  • ☐ Store all Roth IRA statements in a secure, accessible location

Important: When you transfer your Roth IRA to a new custodian, your contribution history does not come with it—and most custodians can’t record or reflect prior contributions, even if you provide documentation. That’s why it’s critical to maintain your own records.

🧠 Why It Matters for College Planning

Roth IRAs are a smart tool for college-bound families:

  • Contributions are always accessible

  • Withdrawals for education avoid penalties

  • They’re not counted as assets on FAFSA, if used for retirement

But without proper records, you risk turning a tax-free gift into a financial aid disaster.

🧾 Contribution Tracking Matters for Traditional IRAs Too

Just like Roth IRAs, you must track your basis (non-deductible contributions) in a traditional IRA to avoid paying taxes twice.

🔹 Deductible Contributions

  • Fully taxable when withdrawn

  • No need to track basis—IRS assumes it's all pre-tax

🔹 Non-Deductible Contributions

  • You must file Form 8606 to report them

  • If you don’t, the IRS may assume 100% of your withdrawal is taxable

  • You could pay tax again on money you already paid tax on

So yes—poor recordkeeping can lead to unnecessary taxes, even though the mechanics differ from Roth IRAs.

🔄 Transfers Between Custodians

  • ACAT transfers don’t carry basis history

  • New custodians don’t know which portion is non-deductible

  • IRS doesn’t track it either—you’re responsible via Form 8606

🧠 Strategic Takeaway

Whether it’s a Roth or traditional IRA:

  • Track your contributions

  • Save Form 5498 and 8606

  • Keep statements and summaries from all custodians

Bottom line: If you’re using a Roth IRA to help fund college, make sure you’re not making this hidden mistake. A few minutes of recordkeeping could save you thousands—and protect your child’s financial aid.

Want a free Roth IRA contribution tracker or a checklist for college-bound families? Reach out to us at maendelwealth.com and let’s make sure your strategy is airtight.

⚠️ Disclaimer

This content is for educational purposes only and does not constitute tax, legal, or financial advice. We are not tax advisors. Please consult a qualified tax professional before making decisions about IRA withdrawals or college funding strategies.

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