In a perfect world, everyone would have a 529 plan — or another education savings account — full of funds to cover their children’s college years. But there are many reasons why that may not be the case for you. Don’t fret, there are other options for paying for college.
You may be considering dipping into your retirement funds. Depending on the type of retirement account you have, you may be able to take an early withdrawal or a loan from your retirement account, which you can use to fund your child’s education.
But using retirement funds to pay for college isn’t always the best move. Before you do it, consider both the benefits and the drawbacks, as well as some potentially less costly alternatives.
Before we jump in, it’s important that you know this article is a basic, high-level overview of some potential options when it comes to using retirement funds to pay for college. Further, because these topics (taxes and investments) are complex, none of what’s written here should be taken as tax advice or investment guidance.
Always talk to qualified tax and investment professionals with questions about your retirement accounts; never rely on blog posts (like this one) to make important financial decisions.
Related: IRA vs 401(k) — What is the difference?
A few pros of using retirement funds to pay for college
If you already have the money saved up, getting money out of your retirement funds to prevent your child from having to take out student loans can have some upsides.
You could avoid an early withdrawal penalty
If you have an individual retirement account (IRA), taking an early withdrawal typically results in income taxes on the withdrawal amount plus a 10% penalty. However, if you withdraw funds for qualified higher education expenses, the 10% penalty is waived.
That said, the withdrawn funds will be still considered taxable as income. Also, this tax break doesn’t apply to 401(k) accounts. But if you roll over your 401(k) into an IRA, the funds would be eligible to avoid the penalty.
You could avoid taxes altogether
If you have a Roth IRA, you can withdraw up to the amount you’ve contributed to the account over the years without any tax consequences at all.
You’re paying interest to yourself with a 401(k) loan
In addition to allowing you to take early withdrawals, some 401(k) plans also allow you to borrow from the amount you’ve saved and earned over the years.
If you borrow from a 401(k) account, that money won’t be subject to taxes like an early withdrawal. Also, the money you pay in interest goes back into your account rather than to a lender.
Drawbacks of using retirement funds to pay for college
Before you raid your retirement to pay for your child’s college tuition, here are some negative aspects to consider.
Tax consequences
Even if you manage to avoid a 10% early withdrawal penalty on your retirement account, some or all of the money you withdraw from a retirement account may be considered taxable income. Depending on how much it is, you could face a huge tax bill when you file your tax return for the year.
401(k) loan rules
If you take out a large loan from your 401(k), then leave your job, you may be required to pay the loan in full right then, regardless of your original repayment term. If you can’t repay it, it’ll likely be considered an early withdrawal and be subject to income tax and the 10% penalty.
You may have to work longer
Taking money out of a retirement account not only lowers your balance but it also means that the money you’ve withdrawn is no longer working for you.
Due to compound interest, the longer you have money invested, the more time it has to grow. But even if you replace it over time, the total growth may not be as much as if you were to leave the money where it is from the start.
Alternatives to using retirement funds to pay for college
Can you use retirement funds to pay for college? Absolutely. But before you do, consider these alternatives.
Scholarships and grants
One of the best ways to pay for a college education is with scholarships and grants, since you typically don’t have to pay them back.
Check first with the school your child is planning to attend or is already attending to see what types of scholarships and grants are available.
Make sure your child fills out the Free Application for Federal Student Aid (FAFSA®) form. The information provided in the FAFSA will help determine their federal aid package, which typically includes grants, federal student loans and/or work-study.
You and your child can search millions of scholarships from private organizations on websites like Scholarships.com and Fast Web. While your child may not qualify for all of them, there may be enough they do qualify for to help reduce their tuition bill.
Federal student loans
As mentioned above, filling out the FAFSA will give your child an opportunity to qualify for federal student loans from the U.S. Department of Education.
These loans have low fixed interest rates, plus access to some special benefits, including loan forgiveness programs and income-driven repayment plans.
With most federal student loans, there’s no credit check requirement, so you don’t have to worry about needing to cosign a loan with your child.
Parent PLUS loans
If you’re concerned about the effect of student loan debt on your child, you can opt to apply for a federal Parent PLUS loan to help cover the costs of college.
Keep in mind that the terms aren’t usually as favorable with Parent PLUS loans as they are with federal loans for undergraduate students. The interest rates are currently higher, and you may be denied if you have certain negative items on your credit history.
Private student loans
If your child can’t get federal student loans or they’ve maxed out what they can borrow and pursued all their other options, private student loans may be worth considering to make up the difference.
To qualify for private student loans, however, you will need to undergo a credit check. If your child is new to credit, you may need to cosign to help them get approved by being a cosigner — or you can apply on your own.
Private student loans don’t typically offer income-driven repayment plans or loan forgiveness programs, but if your credit and finances are strong, it may be possible to get a competitive interest rate.
Balance you and your child’s needs
Using retirement funds to pay for college is one way to help your child. But you probably don’t want to risk your future financial security. Take the time to help your child consider all of their options to get the money they need to pay for school.
Learn more
- How to student loans affect your credit score?
- What happens if you just stop paying your student loans
This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.
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