Dear Carrie: Can I borrow from an IRA account to pay for my daughter's college education? What are the parameters and pitfalls?
-- A Reader
Dear Reader: Your question combines two of the issues I'm asked about most often: paying for college and planning for retirement. These are pressing needs for most Americans, and they are often competing ones.
I have a "bad news/good news" answer for you. The "bad" news is that you cannot "borrow" from your IRA for any reason. The "good" news is that you cannot borrow from your IRA for any reason -- and it's good because it helps you preserve what is probably the cornerstone of your own retirement plan.
IRA "HARDSHIP" DISTRIBUTION
Many company-sponsored 401(k) plans do permit plan participants to borrow from their accounts -- to borrow from themselves, in other words. IRAs don't offer that feature. But like a 401(k), you can make what the Internal Revenue Service calls a "hardship distribution" from your IRA.
Here's how it works. Typically, if you withdraw money from your IRA or 401(k) before you turn 59 1/2, you'll have to pay a 10 percent early withdrawal penalty in addition to income tax. But in some instances, your withdrawal can be considered a hardship distribution, and the IRS will waive the 10 percent penalty.
For example, if you want to take money out of your IRA to cover medical expenses above a certain percentage of your income, or for a down payment on a first-time home purchase (up to $10,000), or to pay for higher education expenses, the IRS allows you to do so penalty-free. (Note that higher education expenses do not qualify as hardship withdrawals from a 401(k).)
But even without the penalty, taking money out of your IRA can be an expensive proposition. You're still on the hook for income taxes, and you're giving up some of your opportunity to build wealth for your retirement.
Let's say you are 50 years old, in the 28 percent tax bracket, and you need $10,000 for your daughter's college expenses this year. If you withdraw that amount from your IRA, you'll pay $2,800 for federal income taxes and possibly state income taxes on top of that. But that doesn't reflect the true cost of your withdrawal.