What Happens When You Pull Money Out of a Retirement Account?

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According to a 2019 report, 74% of adults have some kind of retirement account, such as an IRA, 401(k), or pension plan. But can you pull money out of your retirement account early?

The IRS charges taxes and penalties for early withdrawals, so before pulling money, you should carefully consider your options. While the IRS waives penalties for retirement withdrawals that pay for college, students and parents should exhaust their other options before turning to retirement savings.

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  • Q. Can you borrow from retirement to pay for college?

    Yes. Savers can make an early retirement withdrawal to pay for college. However, borrowing from retirement accounts may result in more taxes and penalties and less money in retirement.

  • Q. How much money can you withdraw from an IRA for education?

    With a Roth IRA, savers can withdraw their contribution to make a qualified education expense without taxes. However, the withdrawal may come with penalties.

  • Q. Can I use my 401(k) to pay for my child's college?

    Yes. Parents can make an early retirement withdrawal to pay for their child’s college degree. However, early withdrawals may result in taxes and penalties.

  • Q. What is considered a qualified education expense?

    The IRS defines a qualified education expense as a cost directly related to college, such as tuition. The student must also meet eligibility requirements.

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Reasons To Pull Your Money Out Early

When faced with large expenses, like college tuition or medical bills, many people consider an early retirement withdrawal. In fact, during the COVID-19 pandemic, 33% of Americans took out money from an IRA or 401(k) account.

However, pulling money from a retirement account early is not always the best choice. Early withdrawals can trigger taxes and penalties. Savers must also factor in the loss of retirement income when considering an early withdrawal.

The rules for early withdrawals vary depending on the type of account. In many cases, the IRS takes an automatic 10% penalty on all early withdrawals unless savers use the money for a qualified expense. For example, the IRS waives the penalty for qualified education expenses, which include tuition and other costs associated with earning a degree.

The Costs of Pulling Your Money Out Early

Although the IRS allows savers to use their early withdrawal for a qualified education expense, doing so can mean a higher tax bill and lost savings for retirement. Savers should carefully consider the costs of pulling retirement money early and speak with a tax professional about the implications.

  • IRA

    Savers receive a tax deduction for putting money into a traditional IRA, but making an IRA withdrawal before turning 59.5 triggers taxes and penalties. Savers can withdraw money from an IRA for college, but it comes at a price.

    The IRS waives the 10% penalty for savers using their withdrawal for qualified education expenses, such as tuition and textbooks. However, savers still need to pay taxes on the withdrawal.

  • Roth IRA

    Savers can make a Roth IRA withdrawal at any time without paying taxes on the money or owing IRS penalties. However, withdrawing capital gains triggers extra taxes and, potentially, penalties. If you have held your account for less than five years and withdraw money for a qualified education expense, the IRS may waive the penalty.

    While a Roth IRA withdrawal might seem tempting, savers cannot repay the money. As a result, they cannot benefit from the future earnings of their investment.

  • 401(k)

    If you make an early 401(k) withdrawal to pay for school, the IRS automatically withholds 20% of the early withdrawal for taxes and takes a 10% penalty on the amount.

    Students may qualify for a waiver on the 10% penalty under the hardship withdrawal rules. However, savers must demonstrate “an immediate and heavy financial need” and may not learn whether they qualify for the waiver until they file their taxes.

  • Federal Government Plan (Pension)

    The Federal Employees Retirement System (FERS) provides pension and savings plan options for government employees. In addition to the federal plan, state and local employees may have their own pension plan.

    The rules for pulling money from a pension vary depending on the plan, but doing so may trigger taxes and penalties. For example, federal employees who pull from their Thrift Savings Plan pay taxes on the withdrawal at their normal tax rate, plus state income tax and an IRS early withdrawal penalty of 10%.

Alternatives to Using Retirement Money

Rather than making an early retirement withdrawal and facing taxes, penalties, and lost earnings, consider other ways to pay for educational expenses. For example, federal education assistance programs, like the Pell Grant, offer free money for college students. Students can determine their eligibility for federal aid programs, including grants, loans, and work-study opportunities, by filling out the FAFSA.

Scholarships and Grants

Each year, students nationwide receive millions in scholarships and grants. Professional associations, private foundations, colleges, and government agencies award scholarships and grants to students based on factors like financial need or merit. Many graduate students also qualify for assistantships and fellowships to cover college costs.

Federal Student Loans

Nearly 70% of the class of 2019 took out student loans. Many federal student loan programs offer low interest rates, flexible repayment options, and loan forgiveness plans. In addition to federal loans, undergraduate and graduate students can take out private loans. However, borrowers should exhaust their federal loan options before turning to private loans since federal loans provide benefits like interest grace periods and loan forgiveness.

Employer Tuition Reimbursement

You can also research employer tuition reimbursement programs to find out if your company will pay for your degree. In addition to these financial aid sources, consider tax credits and deductions that lower the cost of a degree. You can also attend colleges with more affordable tuition rates.

Portrait of Genevieve Carlton

Genevieve Carlton

Genevieve Carlton holds a Ph.D. in history from Northwestern University and earned tenure as a history professor at the University of Louisville. An award-winning historian and writer, Genevieve has published multiple scholarly articles and a book with the University of Chicago Press. She currently works as a freelance writer and consultant.

See articles by Genevieve

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