Some parents dip into their retirement savings to help their children pay college tuition. But the proportion of parents using retirement accounts to pay for college is declining, as families begin to make more economical college choices.
The percentage of parents tapping their 401(k)s or IRAs to pay for their children's higher education spiked in 2010, with 6 percent of parents withdrawing an average of $8,554. In 2011, the proportion of parents withdrawing money from retirement accounts fell to 4 percent, and the average distribution declined significantly to $4,102, according to a Sallie Mae and Ipsos survey of 813 college students and 798 parents of college students. This is similar to the 3 percent of families, including undergraduates ages 18 to 24, who withdrew an average of $5,318 from their retirement savings accounts in 2009.
Sarah Ducich, senior vice president of public policy at Sallie Mae, says families are withdrawing less from their retirement accounts this year because they are choosing more affordable college options. "Families that were making decisions about college in the spring of 2009 were stuck and they needed to find some way to pay for college," she says. "This year they had a year to adjust. Now families are behaving differently and making more cost-conscious college choices."
Fewer parents are taking loans from their retirement accounts to help with college costs. Only 1 percent of parents took an average retirement account loan of $2,779 in 2011, down significantly from the 3 percent of parents who borrowed an average of $6,901 last year.
Early withdrawals from retirement accounts can be expensive. Those with 401(k)s pay income tax, and if they're younger than age 59 ½, they must pay a 10 percent early withdrawal penalty on the amount withdrawn. Retirement account withdrawals can also affect your child's eligibility for federal financial aid in future years. "When you take a distribution form a retirement plan, it's going to count as income on the subsequent year's FAFSA and it is going to count against you for financial aid," says Mark Kantrowitz, publisher of FinAid.org and author of Secrets to Winning a Scholarship. Some parents delay retirement account withdrawals until their child's senior year of college so that it won't result in a decline in their financial aid package. "If you are getting need-based financial aid, try to withdraw from retirement accounts in the last year after you fill out the last financial aid forms," says Tim Higgins, a certified financial planner in Marlborough, Mass., and author of Pay for College Without Sacrificing Your Retirement: A Guide to Your Financial Future.
It's slightly more cost-effective to use an IRA for tuition costs. IRA withdrawals applied to higher education expenses such as tuition, fees, and books are exempt from the early withdrawal penalty, but still subject to regular income tax and can negatively impact financial aid. Parents who withdraw money from Roth IRAs before age 59 ½ must pay income tax only on the portion of the withdrawal that comes from investment earnings. However, once the money is spent, it can be difficult to rebuild a large balance in an IRA. Contributions are limited to $5,000 per year, or $6,000 for those age 50 and older.