Anyone preparing to go back to school has probably considered paying tuition, at least in part, with their retirement savings. After all, the money is just sitting there, waiting to be used.
But that doesn’t necessarily mean you should use it to pay for your degree.
“Don’t do it,” says Kathy Ruby, senior college financial consultant with College Coach®. “Just back away from the retirement account. A lot of people ask me about taking money out of their retirement account, but there’s so many more drawbacks than benefits.”
The pitfalls of using retirement savings to pay for college
You would be hard-pressed to find a financial planner or investment advisor who would tell you to tap into your retirement fund for anything other than retirement. Retirement savings accounts, especially those that allow you to put in pre-tax money, are designed to keep you out until you hit retirement age. There are extensive regulations imposed on these accounts – 401(k)s, traditional IRAs, SIMPLE IRAs, 403(b)s – that severely penalize you when you try to take money out before you turn 59½.
For example, if you take money out of these accounts early you will face a 10 percent penalty, and you will pay income taxes on that money at your current tax bracket. After penalties and taxes, you could walk away with between 20 and 45 percent less than the amount you withdrew.
By contrast, most federal student loan interest rates max out at a little less than 8 percent (of course, you have to be at least a half-time student – which typically means taking 8 or 10 credit hours – in order to qualify for student loans).
Pulling money out of your retirement savings could also jeopardize your chances of qualifying for financial aid, Ruby says, because the extra money is counted as income and could make it appear as though you make more money than you actually do.
Some retirement savings accounts, however, will allow you to take money out of the account to pay for qualified higher education expenses. You won’t pay the 10 percent penalty, but you will still have to pay income taxes on the money.
What to remember if you use your retirement savings to pay tuition
If you do choose to use your retirement savings to pay for part of your college or post-secondary education, it’s important to replenish the money you take out.
“Most people forget to replenish it, or aren’t disciplined enough to do it,” says Mo Vidwans, Certified Financial Planner and owner of Vidwans Financial, based in suburban Ann Arbor, Michigan.
To help ensure you’ll be able to put back in what you take out of savings, calculate the return on your college investment before raiding your retirement. If your new degree will help you bring in thousands more dollars each year, you’ll be able to replenish what you take out, plus interest – as long as you’re committed to doing so.
“Withdrawing money from your retirement account has to be the last, last, last resort,” Vidwans says. “But if you’re advancing yourself to a career with much higher demand in the market, it is an option. Just remember to repay yourself.”
Also think about how many classes you’re taking. If you only need a couple more classes to obtain your degree, you’ll need to take out a lot less money than you would if you needed a full two years of school.
If you’re nervous about tapping into your retirement savings, there are other options. For example, you could take a loan out against your retirement savings account. It works like any other loan, where you have to pay interest on what you borrow, but things could get pretty dicey if the account you’re borrowing from is tied to your job and you lose that job. So only consider this option if the loan terms are the absolute best you can get and your job is secure.
Ideally, the terms will be so good that they make up for the returns you’re losing by pulling some of your money out early, Vidwans says.
A final word of caution: There are more than a dozen regulated retirement savings accounts out there, and the IRS imposes different rules on each one, depending on your circumstances. So read up on the stipulations of your individual account, or talk to an accountant or tax advisor, before you withdraw.
This post was written as part of the University of Phoenix Versus Program. I’m a compensated contributor, but the thoughts and opinions are my own.
College Coach® is a registered trademark of College Coach, LLC.