Paying for college isn’t cheap. Tuition is a huge cost and most look for alternative ways to pay. If you have a retirement fund, college tuition withdrawals may be an option for you. While this can be helpful, it’s important to know the rules and potential penalties involved.
While certain retirement funds allow college tuition withdrawals, you could also benefit from an alternative. Should you sacrifice your retirement funds for college tuition? Deciding on the best route starts with understanding your options first. This guide will walk you through the key details to help you make an informed decision.
The Implications of Retirement Fund College Fund Tuition Withdrawals
You might think about using a retirement fund for college tuition withdrawals for your children or even yourself. Thankfully, the IRS offers exemptions for withdrawing funds from certain retirement accounts to pay for college tuition.
For education, the IRS considers these qualified higher education expenses:
- Tuition
- Books
- Supplies and equipment (e.g. laptops, sports gear, musical instruments, etc.)
- Mandatory fees for enrollment (e.g. application fees)
Each retirement account has its own set of rules and conditions. Consulting with a financial advisor can help you determine which exemptions apply and whether it’s the right choice for your situation.
401k Retirement Funds for College Tuition Withdrawals
Tapping into your 401k to pay for college tuition might seem like a quick fix. However, consider the upsides and downsides of using these retirement funds for college tuition withdrawals:
- You can access your retirement fund for college tuition withdrawal without waiting, which helps if you need money right away for tuition.
- You can avoid the 10% early withdrawal penalty using the funds for qualified education expenses.
- You don’t have to pay back the money you withdraw from your 401k, unlike a loan.
- You’ll still pay income taxes on the amount you withdraw, which could be a big hit come tax time.
- You lose out on the growth money you could’ve earned—setting back your retirement goals.
- You can only cover tuition and related education expenses.
- You will face a 10% penalty on the withdrawal if you make it before age 59½.
- You can’t use your 401k student loans; penalties will still be enforced.
Traditional IRA for Retirement Funds for College Tuition Withdrawals
A traditional IRA can also cover college expenses, but there are specific rules to know. Here’s a simple breakdown of the pros and cons:
- You can use the funds for qualified education expenses, even under 59½, and avoid the early withdrawal penalty.
- You can tap into your contributions and earnings, giving you more money to cover tuition.
- You don’t have the five-year rule when using these retirement funds for college tuition withdrawals, unlike a Roth IRA.
- You can use the funds for education expenses for your spouse, children, or even grandchildren.
- You’ll still pay income taxes on the amount you withdraw.
- You’re reducing your retirement savings and potential growth.
- You only have penalty-free withdrawals for tuition and other qualified education expenses.
Roth IRA Retirement Funds for College Tuition Withdrawals
A Roth IRA for college can be a flexible option for paying expenses, but it comes with its own rules:
- You can withdraw your contributions anytime, tax-free and penalty-free. This gives you easy access to cash for tuition.
- You can also use earnings without penalties for qualified education expenses. However, you must have the IRA for at least five years. You must pay taxes on withdrawals, even for education, if you’ve had the account for less than five years.
- You can use a Roth IRA for college, which isn’t counted as income on financial aid applications. It won’t affect eligibility for grants or loans.
- You’re still hurting your nest egg whenever you use your retirement funds for college tuition withdrawals.
Alternatives to Using Retirement Funds for College Tuition
Draining your retirement account isn’t the ideal scenario to pay for tuitions expenses. Saving for college with another financial vehicle may be a better option.
Educational IRAs
Educational IRAs, or Coverdell Education Savings Accounts (ESAs), are designed specifically for education expenses. Funds in an Educational IRA grow tax-free, so you won’t pay taxes as long as the money is for qualified education expenses.
You can use these funds for various education expenses, from elementary school to college. Educational IRAs allow you to use the money for more than just tuition, such as computers or tutoring, as long as it’s education-related. You aren’t faced with the same restrictions for using your retirement funds.
However, these accounts have low contribution limits. They may not be enough to fully fund education costs. If you have a high income, you may not qualify to contribute.
One major restriction is the expiration date. You must use the money before the beneficiary turns 30, or it will be subject to taxes and penalties. The exception to this is if the beneficiary has special needs. Also, you can’t use the money for anything other than education without taxes and penalties on the earnings.
529 College Savings Plans
A 529 plan is another alternative for saving and paying for education. It offers several advantages that make it a preferred choice over using retirement funds. For starters, contributions grow tax-free.
Withdrawals are also tax-free if you use it for qualified education expenses. Unlike IRAs, 529 plans also have higher contribution limits. This makes it easier to build a substantial education fund for the beneficiaries.
You'll also have more flexibility than using a retirement account, like a Roth IRA for college. A 529 Plan covers expenses for K-12 tuition (up to $10,000 annually) and college.
This even includes room and board. Some states even offer deductions or credits for contributions to their state-sponsored 529 plans. Anyone can contribute to a 529 plan regardless of your income level.
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Stewart Willis is the founder and president of Asset Preservation Wealth & Tax, a financial planning firm in Phoenix, Arizona. Investment advisory services offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.
The commentary on this blog reflects the personal opinions, viewpoints and analyses of the author, Stewart Willis, providing such comments, and should not be regarded as a description of advisory services provided by Foundations Investment Advisors, LLC (“Foundations”), an SEC registered investment adviser or performance returns of any Foundations client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment, legal or tax advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Personal investment advice can only be rendered after the engagement of Foundations for services, execution of required documentation, including receipt of required disclosures. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Foundations manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Any statistical data or information obtained from or prepared by third party sources that Foundations deems reliable but in no way does Foundations guarantee the accuracy or completeness. Investments in securities involve the risk of loss. Any past performance is no guarantee of future results. Advisory services are only offered to clients or prospective clients where Foundations and its advisors are properly licensed or exempted. For more information, please go to https://adviserinfo.sec.gov and search by our firm name or by our CRD # 175083.
