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Should You Tap Into Your Retirement Funds to Pay for Education?


Across the U.S., unemployment is high and salaries are low. Job placement depends on several factors, not in the least being education level. Attaining an undergraduate- or graduate-level degree costs a lot of money, yet not everybody can afford the costs. For those who have some sort of wealth stowed in retirement fund(s), SmartAsset addresses the important question: Should you tap into your retirement fund to finance education?

Find out now: What will it cost to go to school?

Education As Important as Ever for Americans

Currently it is crucial for a person in the U.S. to obtain a college degree, according to a recent article issued by Northwestern University. The article, titled “Fact and Fiction About Getting an Education,” discusses the value proposition of higher education. Dispelling common misconceptions, the commentary discerns that while unemployment levels are high and salaries are low, the numbers are even more severe for people who didn’t go to college. In addition, fewer than 1% of undergraduates borrow as much as $100,000 for college; 30% of private and 40% of public institution students graduate with a bachelor’s degree without education debt.

The case has been made for the importance of education, but its affordability is questionable depending on one’s personal circumstances. According to the National Center for Tuition Statistics, between 2000–2010, the cost of undergraduate tuition, room and board at public institutions increased 42%; meanwhile, prices at private, nonprofit schools jumped 31% (each respectively with inflation adjustment).

As the majority of Americans still consider higher education crucial, they are tapping into numerous resources to receive it. A recent study issued by Sallie Mae titled, “How America Saves for College 2013,” revealed that while the majority of families are putting away for retirement, they frequently intend to dip into retirement savings to help cover college expenses. According to Wells Fargo, regulations concerning traditional IRAs and Roth IRAs have been adjusted so that withdrawals can be made to pay for qualified higher education expenses. A person can use the monies to pay for their own education, or that of their children and grandchildren.

Hardship Withdrawal is an Option, But Not the Best

One way to obtain funds through your employer’s 401(k) plan is by making a hardship withdrawal. Agencies are not obligated to provide this kind of relief, so make sure to check with your respective plan. What’s more, an account may have specific criteria defining a hardship, which sometimes render education expenses invalid. Some common allowances are medical expenses, principal real estate purchases, tuition and education costs, eviction and foreclosure prevention, burial or funeral expenses and principal residence repairs.

It should be noted that companies impose penalties when a person takes out a hardship withdrawal. Individuals under the age of 59 1/2 must pay a 10% penalty for taking the premature distribution. In the case of 401(k) plans, an individual can neither make an elective contribution nor an employee contribution, for a minimum of six months after receiving the hardship allocation.

Loans Offer Safe Access to Retirement Funds, But with Strict Time Limits

A different method is to take a loan out against your 401(k) or IRA. This gives borrowers the advantage of dodging taxes and penalties that come with hardship withdrawals. You can do this as long as you pay off the entirety of the credit. Depending on the type of loan you take out, you have limited time to repay the amount. For instance, you can take up to a 5-year, penalty-free loan through your 401(k), as long as you pay it back on time. You can also access funds from your IRA, but need to pay it back within 60-days to avoid taxes and penalties.

Of course, other stipulations may make retirement fund dipping cost prohibitive. For instance, amounts withdrawn from IRA or 401(k) accounts are considered income for the year. This in turn can deplete the education loan amount for which you or your loved one is eligible. You will also be taxed on your withdrawal. Check with your respective retirement plan to get complete scoop.

Section 529 and Other Options

One alternative is the Section 529 plan. Legally known as “qualified tuition plans,” Section 529 is tax-advantaged and enables individuals to pay into prepaid tuition or college savings plans. The monies allocated to these funds are then invested by qualified brokers, with various allocation options, for future returns.

Two important things to note: a) prepaid tuition plans are generally subject to additional fees for enrollment, maintenance and asset management; and b) college savings plans are subject to broker and annual distribution fees. Yet other tax-advantaged methods to put away for college include the Coverdell education savings accounts, Uniform Gifts to Minors Act (“UGMA”) accounts, Uniform Transfers to Minors Act (“UTMA”) accounts, tax-exempt municipal securities, and savings bonds.

The word on the street from financial planners is that it is not necessarily a good idea to access your retirement funds. But each person’s situation is different. Retirement fund tapping is a surefire way to deplete your funds for the future, as it limits your odds for favorable future gains. Also known as opportunity cost, whatever amount you withdraw will no longer be a part of the total investment for as long as it is absent from the retirement fund.

It is important to compare  the opportunity cost to the interest you will be expected to pay on a college loan. Generally, student loan interest is low and can be applied as a deduction for tax purposes. All things considered, before making any rash decisions, be sure to assess the condition of your overall portfolio, who will be responsible for replenishing these funds, and current and future market conditions.

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