What to Know Before Using Retirement to Pay for College

Most parents want to help their child pay for college. After all, a college education can help set them up for future success, and the cost of attending can be quite high.

In some cases, this leads parents to consider using their retirement savings to help their child pay for college. This includes 401k withdrawals and IRA withdrawals.

While this can seem like a reasonable idea on the surface, it does come with potential drawbacks. This means you need to examine the situation closely before you use any of your retirement savings for anything other than its original purpose: providing you with funds after you retire.

Before you withdrawal your retirement savings or take out a loan against the account’s value, here’s what you need to know. *Please note: we are not financial advisors. You should always consult a certified financial planner when making decisions regarding your retirement.

Retirement Account Options for College Expenses

Typically, there are two options for using your retirement account to help your child pay for college. First, you can withdraw the money. Second, you can take out a loan against its value.

However, which options are available to you depend on the kind of retirement account you hold. Additionally, each type of account comes with its own restrictions and potential penalties.

Using a 401(k) Withdrawal to Help Your Child Pay for College

pay for collegeTypically, a 401(k) withdrawal for education is the hardest to pull off unless you are at least 59 ½ years old.

Once the account owner hits that age, money can be withdrawn for any purposes, including helping your child pay for college.

However, if you aren’t old enough, not every account allows money to be pulled for college expenses. In some cases, if you are at least 55, your plan may let you make a withdrawal for your child’s educational expenses if it considers the request a qualifying “financial hardship.” But, some accounts won’t see these costs as eligible for hardship distributions.

If you are able to make a withdrawal, there are financial consequences. First and foremost, that money counts as income and will impact your income taxes. Exactly how much you’ll owe varies depending on your unique situation. It will also affect your child’s FAFSA the following, if they have to include information about your income, impacting their eligibility for need-based aid. This is why, if planning to do so, you may want to withdraw the money in your student’s freshman year in high school so that it isn’t included in the FAFSA calculations.

Additionally, there is a 10 percent early withdrawal penalty if you aren’t 59 ½.

That means, if you request a withdrawal of $10,000, $1,000 will be removed as a penalty, and you’ll only receive $9,000 to go towards helping your child pay for college.

A 401(k) withdrawal is also permanent. That money cannot be repaid into your account. Once you pull it, it’s gone, and there isn’t much you can do to make up the difference if you already max out your contributions, making it a serious hit to your retirement.

Ultimately, a 401(k) withdrawal isn’t ideal for most parents, particularly with the penalties and tax implications.

401(k) Loans to Help with Paying for Your Student’s College

Depending on your plan, you may have the option of taking out a 401(k) loan. This differs from a withdrawal since you are technically borrowing money from your retirement account and will have to pay it back.

Like any loan, you’ll need to make monthly payments and pay interest. However, the interest also goes into your 401(k), helping you compensate for borrowing the funds to some degree.

There are limits regarding how much you can borrow to help your child pay for college. Usually, you can request up to $50,000 or half of the vested account balance, whichever is lower.

Generally, you have five years to repay the loan, and the payments are made through payroll deductions.

The interest rate you pay varies depending on your plan, so you’ll need to discuss that with the company that manages your account.

Whether you have to deal with tax implications depends on your situation. The funds aren’t automatically considered as income. As long as you pay it back and don’t leave your job during that time, you don’t have to count it on your taxes.

But, if you leave your job, the remaining balance is then considered income if it isn’t repaid immediately, and you do owe taxes. Further, if you default, the money will count as income as well. It will also trigger a 10 percent early withdrawal penalty on the amount that hasn’t been repaid.

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Using a Roth IRA to Pay for College Expenses

Roth IRA withdrawals that help your child pay for college work differently. Since the money is contributed post-tax, you avoid the 10 percent early withdrawal penalty regardless of your age.

Additionally, you can use the full amount you contributed without a tax penalty as long as the account has been established a minimum of five years before you remove any funds.

For example, if you contributed $40,000 to a Roth IRA that has grown to $55,000 thanks to earnings, you can withdrawal up to $40,000 without paying additional taxes. However, anything beyond that amount is taxable as income, even if it is used to help your child pay for college.

However, even though it isn’t taxed again, the money can count as an asset, which may affect your child’s FAFSA.

Using a Traditional IRA Withdrawal to Help with Your Kid’s College

Using a Traditional IRA for your student’s college expenses is similar to a Roth IRA, but you don’t get the tax benefits. Those withdrawals are taxable, so they have to be included as income.

This means the IRA distribution for education may affect your child’s FAFSA the following year, which could harm their chances of getting need-based aid in the future.

Are There IRA Loans to Help Your Child Pay for College?

Unlike some 401(k) accounts, you cannot borrow against an IRA, regardless of the type.

This means, if you are turning to an IRA to help your child pay for college, your only option is a withdrawal.

Additionally, an IRA can’t be used as a form of collateral on a secured loan of any kind, so there aren’t alternative approaches for getting an indirect IRA loan.

Other Ways to Help Your Child Pay for College

If you want to help your child pay for college, you do have some options. For example, you can consider a Parent PLUS Loan or look at private student loans.

These options don’t impact your retirement account but still gives your student access to additional money for college. Each option has its benefits and drawbacks, but it can be worth exploring.

If you want to learn more, here’s an article that discusses the differences:

What I Say to Someone Considering Using Retirement Funds to Pay for College

So now that you know the facts and logistics behind using your retirement to pay for college, I do want to say this:

You can always borrow to pay for a college education. You cannot borrow to fund your retirement.

My personal belief is that parents should put their financial future first. Sometimes this means your child has to choose a more affordable university or enroll in a community college for the first two years or, my personal favorite, start hustling and win some scholarships to help pay for college. There are other options than putting your future at risk.

How Your Child Can Pay for Their Own College Education

Like I mentioned, another great way to help your student pay for college on their own is to support them in their search for scholarships. There’s still time to apply, even if your child needs money for the fall semester.

If you and your student would like more information about how to find scholarships sign up for our free college scholarship webinar! It’s an excellent way to receive some free training about locating scholarships and the rest of the process!

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