College is expensive. A 2018 survey indicated that in-state tuition at a state university averaged over $25,000, while a year of school at a private college cost over $50,000. It’s not surprising that Americans now owe over $1.5 trillion in student loan debt. People concerned about paying for their children’s college education sometimes consider tapping into their retirement savings to do so. After all, retirement account funds can often be withdrawn, albeit with some penalties, and using them to cover tuition costs could help your child avoid long-term student loan debt. However, is it smart to use retirement money for college instead? Before deciding to do so, here are four things to consider.
1. Mind the Timing
When you think about using your retirement savings to fund your child’s education, one of the first things to consider is the timing. How long do you have before you retire? If you plan to work for one or more decades and pay into your retirement account, you may have adequate time to recoup your losses and meet your target savings goals. However, if your retirement is only a few years away, a significant withdrawal to pay for college tuition could significantly impact your retirement savings plans.
Additionally, you should also compare your financial situation to that of your child. Upon successful completion of college, a graduate will have decades of earning potential that’s 56% higher than that of people without a degree. If you’re closer to retirement or otherwise will be hard-pressed to meet your retirement savings target if you withdraw money to pay for tuition, it may make more financial sense for your child to obtain a student loan instead.
2. Factor in Lost Gains
Even if your retirement timeline indicates that you could use retirement savings to cover college tuition, it doesn’t mean you should. An early withdrawal from your retirement savings account could represent a significant opportunity cost as you’re preparing for retirement. If you withdraw $50,000-$100,000 to pay for your child’s education, you could lose out on the earnings potential that money could have had if you’d left it in your account. The return that money could have generated might’ve allowed you to retire much more comfortably, or perhaps earlier than planned, if you hadn’t chosen to use it to cover your child’s education costs instead. When you start to factor in the opportunity costs, it often makes more sense to consider options other than retirement savings to pay for your child’s education.
3. Watch for Penalties and Taxes
Federal tax laws do provide some relief for people using their retirement savings accounts to pay for education. In most cases, if you withdraw money early from an IRA to pay for qualified education expenses, you won’t be liable for the 10% early withdrawal tax that typically has to be paid. However, the withdrawal may be counted as income when it comes time to file your taxes, so ensure you check with an accountant when considering this option.
Withdrawing money from a 401(k) retirement account is a little more complicated. However, these accounts can sometimes be “rolled” into an IRA from which you can withdraw funds. Alternatively, 401(k) account holders can also borrow from their 401(k) account to pay for things such as college tuition. However, the amount borrowed from the account must eventually be repaid. Additionally, it could affect things such as your credit score and the amount of overall growth your retirement account accrues over time.
4. Weigh Other Options
Before you tap into your retirement savings account to pay for college tuition, it may make sense to shop around a bit first. Even if you’re concerned about your child being saddled with student loan debt, many other options can defray the cost of a college education or cover it completely. Depending on the situation, you may be able to help your child cover the high cost of college tuition without significantly disadvantaging either of you.
Many colleges offer grants for students who qualify due to their academic or athletic abilities, or because of their financial situation. This should be a major discussion point as your child and you begin the search for a good college to attend. Additionally, many government and private organizations offer grants as well; you should research those and apply for the ones that are a good fit for your child’s situation. Finally, it may make sense for your child to consider a college with much lower tuition that doesn’t impact either of you so much financially. Attending one would allow your child to get a college education while helping both of you avoid tough financial choices such as tapping into retirement savings or incurring high levels of student loan debt.
While we all want the best for our children, including the best possible education, how you decide to pay for a college education is a complex issue. If you’re contemplating using your retirement savings to cover tuition and other costs, you should definitely consider all the pros and cons. The costs of doing so can often outweigh the benefits, especially if you’re nearing retirement age and will need that money to prepare for life after work. If you’re trying to determine if your retirement savings is the best way to pay for college, talk to a trusted financial advisor to see if there are any better options out there. In many cases, a good financial advisor can help you select an option that allows you to fund your child’s education while continuing to build your retirement savings at the same time.