Saving For College Using Your Retirement Plans: Making Early Distributions Retirement Accounts

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If you're like many people, you may not have a traditional IRA or a Roth IRA. Maybe you have some other form of retirement savings in some sort of retirement account. Not surprisingly, these accounts are intended to be there for you when you retire; however, many of them are available under limited circumstances to pay for other expenses, including qualified educational expenses.

The following list is by no means all-inclusive, but it does cover many of the major types of self-funded and employer-sponsored retirement plans and what the tax consequences are if you need to take a distribution to pay for college expenses:

• 401(k) plan: This plan allows you to make pre-tax contributions to a retirement fund for your benefit. Your employer sets up and administers the plan and may match all or part of your contribution. If you take an early distribution (a so-called hardship distribution) from this plan to pay for educational expenses, be prepared to pay a lot of tax on the distribution. You'll pay income tax at your top tax bracket on the full amount (remember, you've never paid tax on any of it), plus a 10 percent penalty. If you absolutely must access money from this account, you're much better off taking a loan from your plan, if your employer allows it, and then making sure to pay it back within five years.
• 403(b) plan: This is essentially the same as a 401(k) plan, but is offered to public sector and nonprofit organization employees. Once again, early distributions for educational expenses are fully taxable and subject to the penalty.
• SEP IRA: A Simplified Employee Pension (SEP) is administered in much the same way as a traditional IRA. The biggest difference is that your employer — not you — will make the contributions to this account for your benefit. Because it runs exactly like an IRA in all other respects, it follows the rules for traditional IRAs regarding early distributions to pay for qualified educational expenses. You'll pay the income tax, but there won't be any penalty.
• SIMPLE retirement account: A Savings Incentive Match Plan for Employees (SIMPLE) may be set up by your employer to follow either the 401(k) plan model or the traditional IRA model. It allows you to make contributions to your retirement fund that your employer matches. Your tax cost, should you take an early distribution to pay for qualified educational expenses, depends on what type of plan you belong to. Beware, though: If you put money in only to take it out within your first two years of participation in the plan, a 25 percent penalty may be tacked on to your tax bill for good measure.