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Can I Use a Roth 401(k) to Pay for College?

You may be able to access contributions without penalty or taxes

Reviewed by Pamela RodriguezReviewed by Pamela Rodriguez

With tuition on the rise, many parents look to their retirement savings to assist with paying for college. Unlike a Roth individual retirement account (IRA), there is no simple way to withdraw funds from a Roth or traditional 401(k). However, you can use a 401(k) withdrawal to pay for college.

Key Takeaways

  • While direct higher education expenses qualify for penalty-free withdrawals from a traditional IRA or Roth account, student loans and interest do not.
  • Early withdrawals (before age 59½) from a traditional retirement account for use in paying student loans will be subject to a 10% penalty, plus any income taxes.
  • Early withdrawals from a Roth 401(k) can be made penalty and tax-free so long as you only withdraw contributions.

401(k) Loans

Some 401(k) accounts allow you to borrow against the funds in your account. Account holders may of 50% of the account balance or $50,000, whichever is less. This loan must be repaid in relatively equal and regular payments within five years, but all repayments, including interest, are deposited back into the original account.

Thus, if tuition costs are not overly burdensome and your retirement savings are robust, a loan can be a relatively simple way to cover education expenses.

401(k) Hardship Withdrawals

If a loan will not adequately cover costs, 401(k) plans often include terms for hardship withdrawals that allow for the withdrawal of funds. The need for funds, however, must be immediate and significant. If you meet the criteria, you are eligible to receive a distribution up to the amount of the need including funds to cover additional taxes or fees.

However, meeting the criteria for a hardship distribution requires that you be deemed unable to meet the need yourself through other assets (or those of your spouse or dependents) and that you have exercised all other aid and loan options through this and any other plan under your name.

In addition, hardship distributions from a traditional 401(k) are subject to income tax and any withdrawal may be subject to the 10% early withdrawal penalty. Roth distributions of contributions are not taxed and will not incur an early withdrawal penalty.

Examples of reasons for hardship withdrawals, per the IRS, include:

  • Tuition and related educational expenses
  • Certain medical expenses
  • Primary home purchase expenses
  • Funeral expenses
  • Payments necessary to avoid eviction or foreclosure

Qualified Distributions

You can withdraw your original contributions to a Roth IRA at any time without triggering a tax penalty. To take money out of your traditional IRA account, and avoid the 10% early withdrawal penalty, requires the distribution to be qualified. Per the IRS, qualified distributions include:

  • Distributions taken at age 59½ or older
  • Withdrawals made after your Roth IRA has been open for at least five years and you’re at least 59½ years old
  • Withdrawals made because you become totally and permanently disabled
  • Withdrawals made to your beneficiary after you pass away
  • Parents are allowed to withdraw up to $5,000 from retirement accounts penalty-free within a year of birth or adoption for qualified expenses
  • Distributions up to $10,000 taken for the purchase of a first home

You can also avoid the early withdrawal penalty if the distributions are less than the qualified higher education expenses you pay. For IRS purposes, qualified higher education expenses include:

  • Tuition and enrollment fees.
  • Student activity fees.
  • Books, supplies, and equipment.
  • Room and board for students enrolled at least half-time.
  • Education expenses required for a special needs student.

It should also be noted that these expenses must be paid to an eligible educational institution or any college or university eligible to participate in federal student aid programs. Receiving student loans or grants is not a condition for using Roth IRA money to pay for college.

Can I Use 401(k) for College Without Penalty?

Yes, you can use funds from your 401(k) and avoid an early withdrawal penalty if the distribution is based on hardship—that is, it’s an immediate and heavy financial need. Tuition and related educational fees and expenses are named expenses that can be immediate and heavy, per the Internal Revenue Service (IRS).

How Much Can You Borrow From Your 401(k) for College?

When taking out a 401(k) loan, the maximum amount is either $50,000 or 50% of your vested balance, whichever is less—regardless of the use of proceeds.

Does a 401(k) Withdrawal Affect Your FAFSA?

Yes, any withdrawal from a retirement account is considered income for purposes of the Free Application for Federal Student Aid (FAFSA). A 401(k) withdrawal—even if it’s used to pay for tuition and educational expenses—will increase your expected family contribution, whether it be taxable income or untaxed income.

Read the original article on Investopedia.