Higher education is expensive, and if loans are taken out to pay for school, it may take 10 to 30 years to repay what you borrowed, depending on the amount and your repayment schedule. While direct higher education expenses qualify for penalty-free withdrawals from a traditional individual retirement account (IRA), student loans and interest don't.
Be aware that early withdrawals from an IRA—if you're not yet age 59½—used to pay for student loans are subject to a 10% penalty, plus any deferred income taxes owed. Early withdrawals from a Roth IRA, however, may be free from penalties as long contributions—and not gains—are touched before age 59½. It's important to determine whether using IRA funds to pay off student loans is viable for your situation.
Key Takeaways
- Although direct higher education expenses are eligible for penalty-free withdrawals from a traditional IRA, student loans and interest aren't.
- Early IRA withdrawals—before age 59½—used to pay for student loans are subject to a 10% penalty on top of any income taxes owed.
- Early withdrawals from a Roth IRA, however, may be free from penalties as long as contributions—and not gains—are taken out before you reach age 59½.
IRAs and Student Loans
Can you use your IRA to pay off your student loans? The quick answer is yes, but ... there are some important factors to consider, including, how old you are and what type of IRA you have. For example, if you have a Roth IRA, you'll have to factor in how long you've had the account as well.
If you are59½ or older, you may withdraw funds from a traditional IRA to pay for your student loans at any time. If you are younger than 59½, you can still use your traditional IRA funds to pay for college loans, but your withdrawals are likely to be subject to both income tax and early-withdrawal tax penalties.
Student loans don't qualify as an exempt purpose to take out an early withdrawal from your retirement account. That being said, direct higher education expenses may be eligible as an exempt, or penalty-free, early withdrawal: costs such as tuition, administrative fees, books, and school supplies.
In the case of a Roth IRA, you can withdraw your contributions at any time without penalty. You can't take out any money you've earned, though. You do have to wait untilyou turn 59½ to withdraw earnings from those contributions without penalty. Once you reach that age, you can withdraw the money tax-free as long as you've had the Roth IRA for at least five years.
Tax Penalty on Early Distributions
To discourage the use of IRA savings prior to retirement, the IRS imposes a 10% tax penalty on any withdrawals of taxable funds made before the account owner has reached age 59½. This penalty is intended to deter those who have other means of generating income, so this restriction doesn't apply if you are totally and permanently disabled.
This penalty is in addition to any income tax that you may owe on funds distributed from your IRA. For example, if your normal income tax rate is 22% and you withdraw $10,000 in taxable funds from your IRA to pay off student loans prior to reaching retirement age, your effective tax rate for this distribution is 32%. Of the $10,000 you withdraw, you will owe $3,200 in taxes.
The Benefits of a Roth IRA
Withdrawing early from a traditional IRA is generally subject to taxation and penalty unless you make after-tax contributions. Even if part of your balance comprises these non-deductible contributions, however, distributions from traditional IRAs aren't made in any particular order, so at least a portion of your withdrawal is taxable.
By contrast, withdrawals of funds from a Roth IRA are more likely to be tax-free and penalty-free, whatever your age, because you paid income tax on those dollars in the year they were earned and contributed.
Because contributions to Roth accounts are always made with after-tax dollars, a person can withdraw their direct contributions whenever they like, in whatever amounts, and for whatever purpose. Only that portion of an early withdrawal that comes from the account's earnings is subject to taxation and penalty.
Contributions to Roth IRAs are always distributed before earnings. Therefore, if your student loan balance is less than or equal to your Roth IRA contributions, you can use those funds to pay off your loans without incurring the additional penalty or paying income tax, even before you reach retirement age.
A Better Way
Regardless of whether you have a traditional or Roth IRA, there is a penalty-free way to use your retirement savings to pay for your education. IRA withdrawals used for qualified education expenses at an eligible institution are exempt from the penalty.
While the amount of your withdrawal can't exceed your total education costs for the current year, you can use IRA funds to cover a wide range of expenses. Qualified expenses include tuition, books, room and board, fees, equipment and supplies, and special needs services.
Repaying student loans isn't a qualified education expense.
Though the 10% tax penalty is waived, you still owe income tax on any taxable amount of your distribution from a traditional IRA. Distributions from Roth IRAs, whether from contributions or earnings, are tax- and penalty-free in this case. This exception applies to educational expenses for you, your spouse, your children, or your grandchildren.
Though this may not be a viable option for college-aged students who haven't yet accrued substantial retirement savings, those who pursue higher education later in life can benefit greatly.
Can I Spend Money from my IRA Tax- and Penalty-Free To Pay for College Loans?
It depends on your age and the type of IRA you have. Direct higher education expenses qualify for penalty-free withdrawals from a traditional IRA, but student loans and interest don't. If you're younger than age 59 1/2, an early IRA withdrawal used to pay for student loans is subject to a 10% penalty on top of any deferred income taxes owed. Early withdrawals from a Roth IRA, however, may be free from penalties as long as contributions—and not gains—are taken out before you reach age 59½. If you are59½ or older, you may withdraw funds from a traditional IRA to pay for your student loans at any time, although you're likely to owe tax on the amount taken out.
Can I Use Funds from My Roth IRA To Repay My Student Loans?
Contributions to Roth IRAs are always distributed before earnings, so if your student loan balance isn't more than or is equal to your Roth IRA contributions, you can use those funds to pay off your loans without facing the additional penalty or paying further income tax, even before you reach retirement age.
Can IRA Withdrawals Be Used to Pay Back Student Loans While a Student Is Still in College?
Yes. Traditional IRA withdrawals used for qualified educational costs at an eligible institution are exempt from the early withdrawal penalty. While the amount of your withdrawal can't exceed your total education costs for the current year, you can use IRA funds to cover a wide range of qualified expenses such as tuition, books, room and board, fees, equipment and supplies, and special needs services. Don't forget hat, although the 10% tax penalty is waived, you still owe income tax on any taxable amount of your distribution from a traditional IRA.
The Bottom Line
Student loan repayments and interest aren't eligible for penalty-free withdrawals from a traditional IRA, although direct higher education expenses are eligible.
Early IRA withdrawals—before you turn 59½—used to pay for student loans or other purposes are subject to a 10% penalty on top of any deferred income taxes owed. However, if you have had a Roth IRA for at least five years, early withdrawals from it may be excluded from penalties as long as contributions (not gains on the account) are taken out before you reach age 59½.
On the other hand, withdrawals of funds from a Roth IRA are more likely to be tax-free and penalty-free, whatever your age, because you paid income tax on those dollars in the year they were earned and contributed.
