August 20th, 2015
The time has come. The kid is settled in college and the bill arrives in the mail. You have a amount due for college tuition, and your savings can’t cover it. What options do you have?
First, consider taking cash out of a traditional IRA or Roth IRA instead. With these IRAs, you will not owe the 10 percent premature distribution penalty on withdrawals you make before age 59 1/2 , as long as the money is used to pay your child’s qualified college expenses.
The good news is when it comes to school costs, the IRS says no penalty will be assessed as long as your IRA money goes toward qualified schooling costs for yourself, your spouse, your children or grandkids.
You must make sure the eligible student attends an IRS-approved institution, however. This can be any college, university, vocational school or other postsecondary facility that meets federal student aid program requirements. The school can be public, private or nonprofit as long as it is accredited. You can find out if the school is on the U.S. Department of Education's Accreditation database.
Once enrolled, you can use retirement money to pay tuition and fees and buy books, supplies and other required equipment. Expenses for special-needs students also count. Room and board also count if the student is enrolled at least half time.
Another option is to claim a hardship and withdraw the money from your 401K. But to discourage these early hardship withdrawals, in most all cases the IRS imposes a hefty financial penalty including a 10 percent early withdrawal penalty if you are younger than 59 1/2. Your 401(k) plan should be dedicated primarily to your retirement.
Also, frequent dips into your 401(k) reduce the amount of money you ultimately have available to reap the benefits of compounding and tax deferral. This, in turn, reduces the overall funds for your retirement.
If you really need to use your 401(k) to pay for college, a better option might be to borrow from it if your plan allows loans. Plan loans are not taxed or penalized, as long as you repay the funds within a specified time period. But make sure you compare the cost of borrowing college funds from your plan with other finance options.
Finally, you could also see if you can set up a home equity line of credit. This may be the cheapest way of cashing out to get money for tuition and not affect your retirement. Payments are amortized just like a mortgage payment and are more affordable. Contact your reputable loan officer to find out how much equity you have in your home.