To say college is expensive is an understatement. The average cost of tuition at a private four-year college averages about $40,000 a year for a grand total of $160,000. In ten years that cost is expected to soar to more than $280,000 for four years, assuming an annual 5% increase.
Under great pressure, more parents are tapping their retirement accounts to help send their children to school. In fact, according to a survey by Sallie Mae and Gallup, the number of parents using retirement funds to pay for tuition has nearly doubled since the financial meltdown of 2008. And going forward, one in four parents is considering tapping a retirement account, like a 401(k), to help pay for college.
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This carries a number of financial risks. Remember, a 401(k) is meant to be a long-term saving vehicle for retirement—a period of 30 years or more during which time you will need to support yourself and possibly a partner and, recently for a growing number of retirees, adult children and aging relatives. The savings is meant to serve as replacement income once you stop working. If you instead use a 401(k) to help pay for a child’s college tuition, you more than likely won’t have enough left for retirement. And, unlike for college, there is no financial aid for retirement.
There are also penalties for withdrawing early from a 401(k). There are some exceptions to the rule, but in general you need to be at least 59½ years old before you’re allowed to make penalty-free withdrawals. That penalty is equal to about 10% of the amount withdrawn. On top of that, you must pay income tax on the amount withdrawn. So let’s say you withdraw $20,000 to pay for your child’s college tuition. If you’re in the 28% tax bracket, you will owe $5,600 in federal income taxes and an additional $2,000 to cover the early withdrawal penalty. In the end, you’ll be left with $12,400, or even less if you also owe state and local income tax. In total, you’ll pay close to 40% in taxes and penalties.
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With so many baby boomers entering retirement with a savings shortfall, parents should not compromise the long-term savings that they’ve worked so hard to build. Whether you’re the student or the parent, affording college should not end up being a life-long compromise. That means students should not borrow more than they can afford to pay back upon graduation, and parents should not sacrifice a comfortable retirement to send their children to school. It’s important to pick an affordable school or community college, apply for scholarships, grants and federal aid and work part-time to help pay for costs. A 401(k) should never be a consideration.
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Image: Neil MacWilliams, via Flickr.com