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Can a parent use 401k funds to pay for college loans without the 10pct penalty??

roderickroderick Registered User Posts: 1,488 Senior Member
are school loans considered 'qualified education expenses'?
When an IRA withdrawal is used to pay for qualified education expenses the money is exempt from the 10% early distribution penalty normally levied on withdrawals before age 59½. Withdrawals can be used for tuition and fees, as well as room and board or other supplies.

Using a 401k or IRA to pay for college
Post edited by roderick on

Replies to: Can a parent use 401k funds to pay for college loans without the 10pct penalty??

  • swimcatsmomswimcatsmom Registered User Posts: 15,701 Senior Member
    No. A loan is not a qualified education expense.
  • roderickroderick Registered User Posts: 1,488 Senior Member
    If you have back up, please provide this extra detail.

    Of course, let me be more specific - it is not any loan, but a college loan, a loan that paid off qualified higher education expenses - to wit, tuition, fees, room and board for college. When paying off that loan, it therefore is paying off those items.

    I found on pg 53 of the irs website on pub 590 a mention of loanas one of the valid ways of paying for qualified expenses (and that would not be subject to the 10 pct penalty). But I might be misinterpreting this.
    When determining the amount of the distribution that is not subject to the 10% additional tax, include qualified higher education expenses paid with any of the following

    • Payment for services, such as wages.
    • A loan.
    • A gift.
    • An inheritance given to either the student or the individual making the withdrawal.
    • A withdrawal from personal savings (including savings from a qualified tuition program).


    Is there a contact for the IRS for this question? Or does anyone have any direct experience with this situation?

    I did nt find an email on the following page, but there are some helpful places to go for info
  • swimcatsmomswimcatsmom Registered User Posts: 15,701 Senior Member
    Quaified education expenses include tuition, fees, books, and required supplies. The qualified education expenses must be incurred in the same year calander year as you are claiming a tax benefit for them. When calculating whether a 401k distribution is tax free for education expenses, you do not have to reduce the expenses by loans taken out to pay the expenses. For instance if you have $10,000 in qualified expenses in 2011 and use $10,000 loan to pay for them, you can still count them as qualified education expenses when calculating the tax free 401k distribution (as long as you do not claim any of the other benefits such as education credits with the same expenses).

    So yes, you can use current year expense you paid for with a loan as a qualified expense. But you can not come back in a subsequent year and pay off the loan and call it an education expense. For instance you cannot take out a $10,000 loan in 2011 then come back in 2012 or 2013 and use a 401k distribution to pay off the loan and call it an education expense because the actual expense was not incurred in 2012.
    You can take a distribution from your IRA before you reach age 59½ and not have to pay the 10% additional tax if, for the year of the distribution, you pay qualified education expenses for:
    yourself, your spouse, or your or your spouse's child, foster child, adopted child, or descendant of any of them.
    Qualified education expenses. For purposes of the 10% additional tax, these expenses are tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution. They also include expenses for special needs services incurred by or for special needs students in connection with their enrollment or attendance.
  • roderickroderick Registered User Posts: 1,488 Senior Member
    thanks for the detailed reply. I also saw something from schwab on the net. Schwab seems to say you could pay off loans even if the expenses were incurred in a year prior to the tax yr we are adding to the 1040. The important distinction schwab makes is you can only be penalty free on the principal paid ot the ira and not earnings.

    in the blurb, schwab is referring to a roth ira. I am quite sure which kind of ira we have. between my wife and I we have a couple types. a ira and a 401k , I think.
    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.

    You Could Use Your Roth IRA to Pay Off Student Loans?but Should You?
  • swimcatsmomswimcatsmom Registered User Posts: 15,701 Senior Member
    I thought you were asking about a 401k funded with tax deductable contributions. As a Roth is funded with non tax deductible contributions and has an entirely different set of tax rules about withdrawals and penalties to a traditional IRA or 401k.
  • swimcatsmomswimcatsmom Registered User Posts: 15,701 Senior Member
    The post you quoted has nothing to do with special education tax benefits. It is normal treatment of a roth. A Roth is funded with after tax dollars (the contributions are not tax deductable). Qualified withdrawals after 59 1/2 do not attract tax on either principal or earnings (that is the point of a Roth as compared to a traditional IRA). Early withdrawal of principal from a Roth is not taxable income as you already paid taxes on it. But early withdrawal of earnings is taxable income and also attracts a penalty. If the early withdrawal was to pay qualified education expenses in the year they were uncurred, then the penalty on earnings would be waived, (but not the income tax).

    A traditional IRA or 401K is quite different. You can use the contributions as a tax deduction. Because of this, when you take a distribution it is usually all taxable income even after 59 1/2. Early distributions will incur income tax and penalties on both principal and earnings. Penalties, but not income tax, may be waived for certain expenses.
  • roderickroderick Registered User Posts: 1,488 Senior Member
    yes, I did say a 401k, and this is actually where the bulk of our funds lie and so , yes, I want to know about the w/drawal rules for a 401k.

    But our first withdrawl would probably be from a ira. This might be a Roth, but I bet it is a traditional. I will check. We also have something from scudder that was originally a SEP-IRA. Are there diff rules for each of these?

    THe 401k w/drawal might be in a couple of yrs , after taking care of child one with funds from the IRA and the SEP. so w/ this info we might better choose whether to do loans or to pay off the costs as they are incurred.
  • LonghaulLonghaul Registered User Posts: 2,509 Senior Member
    401k rules differ from IRA rules. Do NOT rely on the Schwab website IRA rules as this will differ from your 401(k) Plan.

    Request a copy of your 401(k) Plan Summary Plan Description (SPD).

    A 401(k) may permit 3 different types of withdrawals, but is NOT required to permit any of these types.

    Step 1 - read the SPD to see the types of withdrawals your specific Plan provides.

    Step 2 - 401(k) Plan Loans are NOT taxable distributions. Instead the loan is similar to an investment. Generally, the participant pays the loan principal and interest back to themselves via after tax payroll withholding each pay period. If your Plan permits loans then this may be a better option than tapping into IRA funds since the loan proceeds are not taxed at time of disbursement. The downfall is if you terminate employment the loan is usually due to be paid in full within 90 days or it will become taxable income and subject to early withdrawal penalties. Also, the loan amount is generally limited to 50% of the vested account balance.

    Step 3 - If the plan permits Hardship distribution then the withdrawal will be taxed as ordinary income, but will not be subject to 10% early withdrawal penalty prior to age 59 1/2. The hardship withdrawal may not include gains made on the deferrals. You will be required to show proof of hardship by providing copies of current year tuition bill.

    Step 4 - The Plan may permit In-Service withdrawals at age 59 1/2 penalty free.
  • thumper1thumper1 Registered User Posts: 63,988 Senior Member
    Just an FYI...I believe a withdrawal from the 401K will STILL be subject to taxes AND will also be added to the AGI of the parents for next year's financial aid applications.

    Not paying the penalty is ONE thing...but there will still be income and tax impacts.
  • swimcatsmomswimcatsmom Registered User Posts: 15,701 Senior Member
    Yes, it is taxable income. My husband is retired and our main income is from his 401k. It is part of our AGI that we report on FAFSA.
  • mazewanderermazewanderer Registered User Posts: 1,399 Senior Member
    There is a new Roth option on the 401(K), so it is only the traditional 401(K) that is subject to tax. Again possibly too new to make a difference to most people.
  • ace550ace550 Registered User Posts: 1,126 Senior Member
    Taking a loan from your 401K is the best deal. You pay yourself the interest of the loan. There is only one drawback. If you change your job, you have to pay back the loan immediately.
  • mom2012and14mom2012and14 - Posts: 888 Member
    This is a very timely thread for us. My H turned 59 last fall and we were thinking about taking 401(k) funds to help D pay for grad school. We hadn't even considered that that would trigger taxable income and then impact the FAFSA for younger sib still an undergrad. Thanks for heads up!
  • SLUMOMSLUMOM Registered User Posts: 3,610 Senior Member
    Roderick, put yourself in the hands of a professional CPA & find all your answers from him/her. I work for a CPA & I don't know how many times a new client has come in and gotten bad advice from a non-professional. Paying a CPA and/or accounting firm is a very wise decision and is worth the money!
  • swimcatsmomswimcatsmom Registered User Posts: 15,701 Senior Member
    Good advice from SLUMOM. When my husband was laid off at 50 (many years ago) and, because of age and health issues it seemed unlikely he would find another job in the same ssalary range, we went to see a financial planner for advice on how to handle things. It cost us a few hundred dollars but it was a life saver as he knew the 401k and IRA rules inside and out and explained to us exactly what we could and could not do to tap into the money without penalties. It was worth every dollar we paid him.

    Just make sure you get someone who really knows his stuff.
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