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Why you shouldn’t pay for college with retirement savings

College costs rise every year and leave many parents worried how they’ll be able to help their child achieve a degree.  In 2011, 4% of those parents withdrew money from their retirement savings to pay for college, according to survey completed by Sallie Mae and Ipsos Market Research.

Many parents have worked for years to acquire the sum of money found in their IRA or 401K, and it can be tempting to use that money instead of finding other lending sources.  Here are three big reasons why you shouldn’t.

  1. Early Penalties. If you are younger than 59 ½, 401k withdrawals have a whopping 10% penalty for pulling that money out, which means you lose 10% of your retirement savings right away.
  2. Repayment Terms. It may seem easier to pay yourself back rather than pay back a financial institution, but it may not be as easy as you think. Loans from your 401k often have short term limits, meaning all of that money withdrawn for education will have to be repaid in five short years. Even worse, if you have to leave your job or you’re laid off, the entire balance may become due right away.
  3. Income Tax. When you withdraw a lump sum from your retirement savings, the government will add that as extra income for the year, and they will be sure to tax you for it. Not only does that mean an outrageous tax bill, it can also hurt your child’s chance of receiving financial aid! Federal aid is awarded to only certain income classes, and your “extra income” for the year could disqualify you from those programs!

There are many options when it comes to paying for education. Borrowing equity on your home, federal aid programs, private student loans, free grant money – try to think of your retirement savings as a last resort.

After all, your child will have many years to repay those student loans, you won’t have that same time to recoup and compound the interest on your retirement savings!