1 Really Bad Way to Pay for College
You may have read that you can take cash from your IRA to pay for college tuition, without incurring the usual 10% penalty on withdrawals made before age 59 1/2. The IRS calls it the “education exception to additional tax on early IRA distributions.”
But just because you can doesn’t mean you should. In fact it’s a pretty dreadful idea.
Among the reasons:
1. You’ll have less money saved for retirement. And not just the amount you withdraw but whatever it might earn, tax-deferred, between now and the time you retire.
2. You’ll still have to pay taxes on the withdrawal. As a result, you’ll net considerably less than you withdraw. Julian Block, an attorney and tax expert in Larchmont, N.Y., gives this simplified example: Let’s say you want to take $10,000 from your IRA. Even if you’re in the relatively low 15% federal income tax bracket, you’ll owe $1,500 in taxes, netting you just $8,500. If your state has an income tax, that will reduce your net further. What’s more, the amount you withdraw will increase your adjusted gross income for the year, which could affect your eligibility for certain tax deductions and even push some of your income into a higher tax bracket.
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Note that this applies to early withdrawals from Roth IRAs as well as the traditional kind, although you can withdraw your contributions to a Roth, but not their earnings, at any time without taxes or penalties. The IRS has more details on its website.
Block suggests that if you own a home, taking out a home equity loan might be a better idea. Not only will you sidestep the problems associated with IRA withdrawals, but some or all of the interest you pay should be tax deductible.
“I would look on an IRA withdrawal as an option of last resort,” Block says.
“Before you go ahead with one,” he adds, “first see what rate is available from Tony Soprano.”
For more advice on paying for college, and to create a customizable list of colleges based on criteria such as size, selectivity, and affordability, visit the new Money College Planner.