Saving For College Using Your Retirement Plans: Using Your Traditional IRA

Buy this book »

As you begin the run-up to college, you may be patting yourself on the back, sure in the knowledge that you've saved every penny you're likely to need to pay for your child's college education. If so, fantastic! You've overcome a huge obstacle, and now all your child needs to do is be accepted to the college of his or her choice.

If, on the other hand, you've left saving for college until late in the day, and are now sweating because you don't have enough funds in your Section 529 plan, Coverdell Education Savings Account, or Series EE or Series I savings bonds, all is not lost. If you're like many people, especially those who had children later but who started saving for retirement early on in their careers, you may actually have adequate money saved to not only fund your retirement but also to make up the difference between college costs and college savings.

Although using some or all the money in your traditional IRA may make perfect sense when you're still relatively young and retirement seems distant and unreal, you need to remember that, while you can borrow for college, you can't borrow for retirement. Use retirement funds of any variety for college expenses only if you're certain that you'll have enough for retirement without that money. If you're far from retirement age, you still have the opportunity to increase your contributions into retirement plans. If, however, you're paying for college expenses only shortly before you'll be needing these funds yourself, be certain that you're not condemning yourself to a lifetime of limited opportunities and beans-on-toast dinners. Retirement now lasts longer, on average, than it ever has, and raiding your retirement savings now could sentence you to 20 to 30 years of subsistence living without adequate funds.

Using Your Traditional IRA to Cover College Expenses

If you've been contributing and saving every year in your traditional Individual Retirement Account (IRA), you may already have a tidy sum socked away and earmarked for your retirement. That money may beckon to you when the bills for your child's tuition and other educational expenses begin to roll in and your savings in other areas just aren't enough to cover them all. Clearly, the temptation is great — that money is just sitting there, you don't need any of it yet for retirement purposes, and your only option may be to either take a distribution from your IRA or take a loan to pay for those pesky college expenses.

What's more, you can do it and not pay an early distribution penalty (if you plan things right). The IRS allows you to take penalty-free distributions from your traditional IRA before you turn 59 and a half years old if that distribution is used to pay qualified educational expenses, although you do, of course, have to pay the income tax on the distribution.

Before you jump in and cash out your traditional IRA, consider these questions:

• How much money will you need in order to retire and maintain your current lifestyle? Calculators that allow you to make this estimate are available on the Internet and in most money management software packages. In addition, any good financial planner should be able to help you make this calculation.
• How much money do you currently have saved in your (and your spouse's) various retirement funds, investment accounts, and so on?
• If you use part, or all, of your current retirement savings to pay for college expenses for your kids, will you still be able to save enough to adequately pay for your retirement after doing so?

Figuring Out Qualified Expenses

Maybe you're quite certain that you have more than you'll ever need and that it makes perfect sense for you to pay at least some of your student's expenses from your traditional IRA. If so, here's what you need to know to avoid paying a 10 percent penalty on your distribution: