Paying (Dearly) For College With Your 401(k)

As the cost of college heads for the stratosphere, some families consider using their retirement fund - 401(k), 403(b), IRA - to cover their education expenses. Many parents find themselves a bit cash-strapped, and while it’s a natural tendency to want to do all you can financially to make sure your kids get the best education possible, I caution against tapping your nest egg to pay for your children’s education. Why? Consider this:

The average age of parents with college bound kids is 40-45. The oldest baby boomer turned 60 in 2006. Ten years from today, when these college-bound parents finally get their children through college and want to start building up their retirement account, the current 60-year-old Boomer will be 70½. At 70½ these older Boomers MUST begin taking required minimum distributions from their retirement funds. How do you think the stock market will react to this major drain of money? Will you be paying off your college loans plus trying to fund your own retirement… in a weak market?

What about 20 years from now when current college-bound parents will be approaching 65 years of age and begin to retire? At that time, the majority of baby boomers will be 70-80 years of age! This huge number of retirees could be draining the government Social Security and Medicare/Medicaid coffers at the same time they are required to take distributions from their retirement funds. How will the government respond to this large expense? Will they raise taxes to offset the cost? Since your 401(k)/403(b)/IRA is fully taxable at ordinary income tax rates, higher taxes in 20 years at the time of your retirement could dramatically reduce the amount of money you’ll have to live on.

While I must issue a disclaimer that I have no idea whether the stock market will be up or down in 10 or 20 years, or whether the government will raise taxes to offset the aging costs of baby boomers, I do advocate that you look at the big picture when planning for college and work backwards by addressing your retirement first.

Furthermore, if you do borrow money from your 401(k) to pay college expenses and then switch jobs, please be aware that the loan must be paid back right away, typically within 60 days of the time you leave. If you don't have the cash to pay off the loan, then the loan balance may be considered a taxable distribution, which means you would owe tax plus a 10-percent penalty, assuming you're under the age of 59½.

Please don’t use a short-term solution to the detriment of your long-term goals. Before you ever consider taking money from your retirement account to finance your children’s education, consult a professional who may have alternative strategies that can help you pay your college expenses without raiding your retirement accounts.


Brian C. Greenberg, CPA, CCPS (Certified College Planning Specialist), is the owner of Brian C. Greenberg & Associates. Mr. Greenberg specializes in innovative tax and financial services. He also hosts "College Bound", a television program that airs in the Delaware Valley and throughout Pennsylvania. He is a broker representative with HD Vest, a non-banking subsidiary of Wells Fargo. Mr. Greenberg can be reached at 856-596-7800 or brian@greenbergcpa.com.

May 2, 2007