Borrowing From Retirement to Fund Your Child's Education

Sep 12, 2013 4:46:08 PM / by Jason Shaw

retirement funds for college

With the soaring costs of higher education, many people struggle with the question of whether to borrow from their retirement accounts to help pay for their children’s college costs.  Although we all want to help our children as much as possible, we have to take care of our future selves as well.  Consider carefully before you decide to tap into your nest egg to help your child pay for college.

Immediate Costs of Taking Early Distributions

Dipping into your retirement can be costly.  Be sure you understand any taxes and penalties that apply for early withdrawal.  There are three primary ways in which you can access retirement funds to pay for your children’s education, and each carries different costs.

401(k) plans are the most difficult to access early.  Although it is possible to make a withdrawal based on economic hardship, you must meet the specific requirements for such a withdrawal under your employer’s plan.  According to the IRS website, an employer may determine that a plan may specifically exclude distributions made to pay for educational expenses.  If you are considering funding your child’s education this way, you will need to find out whether it is allowed under the particular rules of your plan.  Even if your withdrawal is allowed, it will incur a 10% penalty if you are under age 59 ½, and you may be prohibited from contributing to the plan again for up to 6 months afterward.  You may also be able to borrow from your plan rather than making a withdrawal.  In this case, you would be able to avoid tax and penalties, but you must pay back the loan within 5 years if you remain employed, or within 60 days if you lose your job.  Otherwise, the loan is treated as a withdrawal, and penalties apply.

IRAs are easier to access, as the 10% tax penalty does not apply to withdrawals taken to pay for higher education expenses.  In the case of Roth IRAs, withdrawals can be taken at any time without penalty, subject to certain limitations.

Long-Range Costs

If you take money out of a retirement plan without incurring a penalty, it may seem that it costs you nothing to do so or that is actually saving you money if your alternative is taking out loans for your child.  You must, however, consider the opportunity cost of dipping into your retirement fund.  Although recent market conditions may lead you to believe that you would not be losing much by taking your money out, it is not safe to assume that the market will behave the same in the future as it has in the recent past.  In fact, the market tends to rebound after periods of low returns, so you may be giving up more in earnings than you may expect.  Generally speaking, the opportunity cost of taking money from your retirement tends to be greater than the cost of taking out student loans due to the low-interest rates available and tax deductibility of many types of loans.

How would this affect your retirement?

Before you make the decision to take money out of your retirement fund to pay for your children’s college, speak with a qualified financial advisor to determine what impact your proposed withdrawals will likely have on your retirement income.  Retirement calculators are available to help you get a general idea, but it is best to go over your expected costs, assets, and expected income with a professional before going ahead with your plan.

The financial professionals at Boelman Shaw Capital Partners in Des Moines can help you sort out how to best assist your child with educational expenses while securing your own retirement.

Tax and accounting services provided through Boelman Shaw & Company, LLC. Advisory services provided through BSC Capital Partners, LLC a state of Iowa registered investment advisor.

Topics: Financial Planning, Retirement

Written by Jason Shaw