Dear Carrie: I recently graduated from college and have both school loans and a Roth IRA. I'm considering pulling some of my Roth IRA money and paying off some of my older, higher interest school loans. I've heard that you can withdraw from a Roth IRA penalty-free as long as it's principal, and not earnings.
Is this true? Can I withdraw a portion of my Roth IRA to pay off some of my student loans? I'd appreciate your help and insight. -- A Reader
Dear Reader: Congratulations on your graduation and for contributing to a Roth IRA. Both are excellent ways to pave the way for your future. And it's exactly this type of forward thinking that I'm going to use as we look at whether it's a good idea to draw from your Roth IRA to pay down student loans.
The short answer to your question is that yes, you can withdraw the principle from a Roth IRA penalty-free. But because you can, doesn't mean you should.
WHAT YOU CAN WITHDRAW FROM A ROTH PENATLY-FREE -- AND WHEN
With a Roth IRA, there's an important distinction between contributions and earnings. Roth contributions are made with after-tax money. Since you've already paid the taxes, contributions can be withdrawn anytime tax- and penalty-free.
It's the earnings on those contributions that may be subject to income tax and a 10-percent penalty, if you withdraw them less than five years from opening the Roth and before age 59 1/2.
As an example, let's say you have $10,000 in your Roth IRA -- $7,500 in contributions and $2,500 in earnings. You can withdraw up to $7,500 without paying a penalty. IRS rules state that withdrawals will be taken first from contributions, so in this case, if you withdraw no more than $7,500, there's no problem. You could take that money and use it to pay down your student loans.
WHY IT MAY NOT BE A GOOD IDEA
While this may seem like a good short-term solution, I'd encourage you to think of the long-term cost before writing yourself a check. Here's why. You can only put so much into a Roth each year. Currently, the maximum is $5,000 with an additional $1,000 catch-up contribution if you're 50 or older. So even if you were to get a windfall, you wouldn't be able to put any more than the maximum back into your Roth in any one year. In the meantime, you've lost the opportunity for potential future tax-free compound growth on the money you've withdrawn.
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