With college tuition ever on the rise, many parents look to their retirement savings to assist with university fees. However, using a Roth 401(k) to supplement education expenses may not be as easy as it is with other retirement plans. Unlike a Roth IRA, there is no simple way to withdraw tax-free funds from a Roth or traditional 401(k), regardless of the reason for needing the funds.
- While direct higher education expenses qualify for penalty-free withdrawals from a traditional IRA or 401(k) 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 deferred income taxes owed.
- Early withdrawals from a Roth 401(k), however, may be free from penalty and tax so long as only contributions, and not any gains, are touched before age 59½.
Taking a Hardship Loan
However, all 401(k) accounts do have a built-in loan feature, which can be useful in times of need. Under the terms of the plan, account holders may take a loan of up to 50% of their balance with a maximum loan amount of $50,000. 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 without depleting your account.
If a loan will not adequately cover costs, 401(k) plans often include terms for hardship distributions that allow for the withdrawal of funds up to the total amount of contributions, not including earnings or employer matching. 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—although Roth distributions are not—and any withdrawal may be subject to the 10% early distribution tax.
Account holders who take hardship distributions are also restricted from making contributions to any retirement account under the same employer for at least six months following the withdrawal.
You can withdraw your original contributions to a Roth IRA at any time without triggering a tax penalty. Qualified distributions are also 100% tax- and penalty-free. A qualified distribution includes:
- Distributions taken at age 59 1/2 or older
- Withdrawals made after your Roth IRA has been open for at least five years and you’re at least 59 1/2 years old
- Withdrawals made because you become totally and permanently disabled
- Withdrawals made to your beneficiary after you pass away
- Distributions up to $10,000 taken for the purchase of a first home
You can also avoid the early withdrawal penalty if a distribution is not more than the qualified higher education expenses. 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
We should also note 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.