Today you may be helping your child decide where to go to college, but pretty soon you'll be dealing with all that entails—including bills. When the time comes, where on earth are you going to come up with all that money?
Your retirement savings might be tempting you at this point. After all, you might have more than enough saved to cover the cost of the bill. But should you dip into your retirement fund to pay it? Most experts say no, and here's why.
There are more options to pay for college than there are for retirement
There are many options available to pay for college. If you earn enough money and the tuition is low enough, many colleges will offer a payment plan with payments spaced out over the course of the semester. In addition, there are many ways to pay the tuition bill without using your own money:
- Grants and scholarships directly from the college offer money to students that doesn't have to be paid back.
- Third-party scholarships also provide money to students—but your child will most likely have to apply for these.
- Work-study opportunities allow your child to work for the university in return for a small stipend.
While there are myriad ways to fund a college education, there's really only one way to fund a retirement: through the savings you already have and will continue to accumulate in the future.
It's easier for your child to pay off student loans than it is for you to work in retirement
Student loans are a necessary solution if you're having problems funding a college education. Still, it's understandable why you might want to foot the bill yourself rather than having your child take out student loans, especially when they're in such a vulnerable financial position as they enter the workforce after college.
Nevertheless, lenders who offer competitive rates and borrower protections have made the process easier than it has been in the past. And if your child has federal loans, they may be eligible for financial programs that can help them pay them off, such as public service loan forgiveness or income-driven repayment plans.
You might be hit with a tax penalty if you withdraw funds early from your retirement account
If you withdraw money from certain types of retirement accounts (such as a 401k) to pay for college before you're age 59 ½, be prepared for a one-two punch to the wallet.
First, that withdrawal will be tacked on as income when you file your taxes at the end of the year, just as if your employer had paid you extra. This will cause you to owe more income taxes to the government when you settle your bill at the end of the year. Then, to top things off, you'll also face a 10 percent early withdrawal penalty. IRA withdrawals don't have to pay the 10 percent penalty fee, but you will still owe income tax on the amount withdrawn from IRAs in some conditions, such as if you withdraw any earnings on a Roth IRA.
Because you'll need to pay taxes and possibly a 10 percent penalty, this means that you'll need to withdraw even more money from your retirement account to fully foot the college bill.
It'll reduce how much financial aid you're eligible for
Normally, money you have saved up in your retirement accounts isn't factored into how much financial aid you're eligible for when you complete the FAFSA. You could have a million dollars stuffed away in your retirement accounts and still be eligible for financial aid.
But all that changes once you withdraw the money from your retirement account. Remember how withdrawals are counted as income, in the above section? That income information will be listed on your tax return—the exact document that the FAFSA uses to estimate how much financial aid you're eligible for. So, when you go to complete the FAFSA next year, it'll look like you had a fantastic earning year, and they may bump you from getting as much financial aid as you really deserve.
Interest rates on student loans are often less than the returns you'll get from keeping your retirement money invested
Let's say that you take student loans out for your child's education. In 2018, federal student loans for undergraduates actually charged 4.45 percent APR. If you take out private loans? Here at CommonBond, we charge rates as low as 3.47 percent APR for student loan refinancing.
Now, consider if you take out money from your retirement account that you could be investing. The long-term returns from investing in the stock market are around 7.0 percent.
At the end of the day, you have two choices: pay 4.45 percent interest (or a similarly low amount), or lose out on an average of 7.0 percent interest. By choosing to pay for student loans rather than losing out on investment returns, you'll come out ahead at the end of the day.
The big picture? Unless you absolutely have no other options, you should consider keeping your retirement money reserved for its original purpose—it will most likely make both you and your child better off in the long run.
None of the information contained herein constitutes a recommendation, solicitation or offer by CommonBond or its affiliates to buy or sell any securities or other financial instruments or other assets or provide any investment advice or service.