Should You Use Retirement Funds to Pay for College Tuition?

You were excited to share in your kid’s accomplishment -- until you saw the cost of attending their school of choice for the next four or more years.

You may quickly find out you weren’t saving for college as much as you should have been. Even if you have access to money in a 529 plan, it may not be enough.

So, you quickly realize that's a financial dilemma:

You simply don’t have enough income and college savings set aside to pay for your child’s college costs. 

At this point, many people consider any possible way to help their children avoid student loan debt.

One option you might consider seriously:

Tapping your retirement funds to pay for college expenses.

While this could be an acceptable move in extremely rare cases, using your retirement funds to pay for college usually isn’t the best move.

Why You Might Consider Tapping Your Retirement Funds

Retirement funds are an attractive source to pay for college because they’re likely your largest savings balance. 

It’s tempting to use part of that money to help your child pay for all or part of their college costs.

It may not seem like a big deal to withdraw a portion of your savings to help your child avoid crippling student loan debt.

The issue is:

Most people don’t have anywhere near enough money set aside to cover their future retirement costs.

This is before people think about taking IRA withdrawals to start paying for college. 

However, there are some people that are retirement super savers. If you’re a retirement super saver you may have saved more money in retirement accounts than you’ll realistically need. 

In this case, which isn’t common, using some of your retirement funds to pay for college might not be the worst idea.

How to Minimize Tax Penalties If You Do

If you do decide to take money out of retirement accounts to pay for college for your children, make sure you’re doing so as smart as possible. 

When you put money in your retirement plan, you likely got tax advantages in one way or another.

Now:

If you’re not careful and don’t follow the rules when you withdraw the money, there could be penalties.

This can be extremely complicated.

It makes sense to consult financial advisors and tax professionals. They can help you see how using money from retirement accounts would impact your financial plan and your taxes.

IRS rules for early withdrawals for college expenses

If you’re over age 59 and ½, you won’t have to pay the 10 percent early withdrawal penalty on your retirement withdrawals. 

Thankfully, you can also avoid this penalty if the costs are used to directly pay for higher education expenses. The expenses must be for a child or other qualifying relatives, though.

That said:

You might have to pay federal tax or state income tax on your withdrawals. This is usually true for tax-deferred accounts such as traditional IRAs.

Contributions to a Roth IRA can also be withdrawn as Roth IRA distributions penalty-free. They’re also tax-free since you already paid tax on the income when you made the contribution. 

If earnings are withdrawn, things get more complicated due to the tax benefits you received when you contributed to the account.

Avoid this if possible.

If it isn’t possible, consult a tax professional to help. 

Money withdrawn from retirement accounts could impact your child’s potential financial aid.

Consult with a financial aid expert to determine how your possible withdrawals would affect financial aid before you make withdrawals.

Why Tapping Retirement to Pay for Your Child’s College Is a Bad Idea

Despite the allure of using retirement accounts to pay for college, it’s generally a bad idea.

You can't borrow for retirement

Most people aren’t in a position to be able to afford both their future retirement and their children’s college costs. 

Your children can take out loans to pay for college, but you can’t take out a loan to pay for retirement. 

While we all want the best for our children, sometimes we have to take care of ourselves first.

This means:

Keeping your retirement funds for retirement and, in some cases, not being able to help pay for college costs. 

While your children may not see this as a blessing now, it can be.

If you use your retirement funds to pay for college and then run out of money in retirement, you’re probably going to turn to your children for financial help.

If you decide to keep the money in retirement accounts and successfully save enough to cover your retirement costs, you may not be a financial burden on your kids in the future.

Missing out on growth potential

When you first start saving for retirement, your contributions are more important than the returns you earn.

Over time, your balance grows to a point where you start earning more in returns than you make in contributions.

College usually comes at a pivotal time for your retirement investments. At this time, your portfolio should be growing rapidly thanks to compounding returns. 

If you withdraw a big chunk of your investments to pay for college, this growth potential is diminished. You take a huge step backward. 

The fact is:

It'll take years to catch up to where you were before you took out the money.

Tips to Avoid Using Retirement Funds for College Costs

It is possible to pay for college without tapping your retirement funds. It may not be easy or ideal, though.

1. Try community college first

Check to see if your state has community colleges that work well with four-year colleges. 

In many cases, you can take some of your general education course work at a cheaper community college then transfer to a four-year school. 

You save because tuition is cheaper and because your child can live at home which saves room and board costs. 

This isn’t the traditional college experience, though, so many people don’t find this is the best fit despite the savings.

2. Choose a more affordable school

Attending your dream school would be nice, but simply attending college is a great accomplishment. 

Out of state tuition costs can be absurdly high. If your child’s dream school is out of state, consider an in-state option, instead. 

Even if your child’s dream school is in-state, you could save money by picking a more affordable college.

Another way to save is by picking a school that’s close to home so you can save on room and board costs.

3. Maximize financial aid

Financial aid for college is extremely complex. There are all sorts of formulas and different factors taken into account when you fill out a FAFSA form.

Different types of assets and income impact financial aid in different ways.

Sometimes, restructuring your money can make a big difference in how much aid your child receives. 

If you aren’t careful, one mistake could cost your child potential aid.

For instance, taking money out of retirement accounts might be counted as income which could limit aid.

For some families, it may make sense to consult a FAFSA expert a few years before you students are ready for college. They can help you structure your finances so you have the best shot of qualifying for financial aid.

4. Apply for scholarships and grants

Applying for scholarships isn’t an easy task. They usually require your child to fill out many forms or write essays on topics that may not interest them. That’s a good thing, though.

Scholarship applications aren’t meant to be fun. They’re meant to weed out the people that don’t really want to put in the effort. This helps increase the odds of winning a scholarship for those that do apply.

There are a ton of different types of scholarships, too. Apply for every type of scholarship you could qualify for. 

Some scholarships are based on need. Others are based on academic achievement. Some are even based on a random qualification like having a parent that served on an aircraft carrier.

Do everything you can to find and apply for as many scholarships that you have a shot of winning.

If you win a handful of scholarships, the time spent applying for the scholarships could easily pay more per hour than time spent working at a minimum wage job.

5. Home equity loan might help, but beware

If you’re on track with your retirement savings, you might be able to help your children pay for college. Even so, you may not want to take money out of your investments to do so. 

If you have equity in your home, a home equity loan or line of credit could be an option. These loans typically come with relatively low interest rates. 

Unfortunately, this is true because the loan is backed by your home.

If you end up defaulting for any reason, your home could be foreclosed on. 

Tread carefully:

This is a major risk.

Don’t consider using a home equity loan or line of credit lightly.

Paying for College Is Difficult

The cost of a college education continues to increase. 

While tapping your retirement funds to help cover college costs seems like an easy way out, it’s usually not a good idea. Instead, focus on how you can minimize the costs of college. 

Once you’ve minimized the costs, earning extra money through scholarships and financial aid can help you close the gap. 

In the worst-case scenario, your child can take out a reasonable amount of student loans to cover the cost to obtain a degree that will help them have a brighter financial future. 

If you don’t tap your retirement funds to pay for college, you may have a brighter financial future, too.

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