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The Dangers of Using Your Retirement to Pay for Your Child’s College

Author: Ethan Smith

As parents, you want to help your child succeed, no matter the costs. However, one of those costs should not be your retirement. According to a 2014 Sallie Mae survey, 7% of families dipped into their retirement to help foot the costs for college. This trend is growing in popularity, but that doesn't mean it is a good financial decision for you or your children.

Where Will You Get Financial Support in Retirement?

There are many readily available s for financing education such as scholarships, grants, and financial aid. When those options are exhausted, there are student loans. Student loans are not ideal, but they are a wiser choice than cashing out your 401K or Individual Retirement Account (IRA). Covestor portfolio manager, Charles Lewis, says, Remember, your kids have their entire lives to pay back their educational costs. But you have a limited time before you retire. (Read more on retirement savings, here: 4 Reasons You Shouldn't Use Your Retirement Savings as a Piggy Bank.)

If you were to pay for your child's college with your retirement, where would you turn for financial help? The government does not offer scholarships or grants for a senior citizen's living expenses, so it is extremely important not to underestimate your retirement living costs, especially health care costs associated with end-of-life care.

You might think that you are setting your child up for financial success by paying for their college expenses, but you are not. You are setting them up to have to care financially for you in your old age. Think about it: your retirement funds are meant to cover your living and health care costs until you die. If that money is not there, then your children will have to help carry the burden.

Consider the Penalties

Cashing in your retirement check early comes with a lot of penalties. If you take out $50,000 early, the average cost to attend a four-year college program, then you will automatically lose $5,000 or 10%. Further, you have to factor in federal tax withholding, federal tax, and state tax. Depending on where you live and your tax rates, this could cause you to lose another $10,000 to $17,000.

The amount of money you are left with for your child's college costs is about 55% of the original $50,000. You will also need to calculate how much money you will lose on the future money earned. For example, if you took out $50,000 of your retirement ten years early, then you will have missed the opportunity to make a little over $35,000 based on a 6% rate of return.

Don't Waste Money on Indecisive Students

Even the most diligent students have been known to change their major or switch career paths altogether. Paying for college with your retirement funds is a risky move, especially when there is no guarantee that your child will finish their degree or stay in school.

It is also important to think about the potential consequences of paying for you child's tuition—are you prepared for your huge sacrifice to be taken for granted? As hard as it might be for your children to pay for their college experience, the hard trial can help them to develop perseverance and a good work ethic. (For more, read: 8 College Financing Flubs.)

What Options Are Available?

It would be far wiser for you to take out a personal loan or a Parent PLUS loan, than dip into your retirement savings. Say you have ten years until retirement, you are more likely to pay off a loan than to replenish the money you took out of your retirement accounts. Personal loans come with higher interest rates, but the money paid on interest is very little compared to the amount of money you would lose to penalties and taxes from your 401K or IRA.

Of course, before even considering taking out a loan for your child's education, consider seeking financial aid, scholarships and federal student loan options. Students have a better chance winning local scholarships than ones that are available to all. Apply for FAFSA every year, even if you don't think you qualify. There is always a possibility that your child will qualify for money or that your child will secure a bigger federal loan. Federal loans are better than private loans because in some circumstances they can be forgiven or the borrower can qualify for income-based repayment options after they graduate.

The Bottom Line

While college expenses are extremely costly, it is even more costly to take the money out of your retirement funds. Before you make the rash decision to touch your retirement fund, talk with your accountant or certified financial planner. It is also a good idea to know exactly how much this move will cost you before you proceed. When in doubt, don't touch your retirement savings at all. (For more information on cutting college costs, see: Save On College Budget Busters.)

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