More families turn to retirement savings for college News added by Benefits Pro on September 3, 2014

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Joined: September 07, 2011

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By Marlene Y. Satter

Parents determined that their children get a college education are digging deeper and paying more as student loans become less popular. But when parents tap retirement accounts to help their kids wear a cap and gown, they may not realize all the costs involved.

That’s according to new research from Sallie Mae and Ipsos, which found that 7 percent of families have helped cover college costs by taking dollars from retirement accounts this year, an increase from 5 percent last year.

Also read: Parents fear effect of college costs on retirement

The latest figures also showed that parent income and savings accounted for more than double what kids paid, at 30 percent vs. 12 percent, while borrowing was down — accounting for 22 percent of 2014’s college costs compared with 27 percent in both 2013 and 2012. Grant or scholarship money accounted for 31 percent.

And, as might be expected, the higher the net worth of the parents, the more they paid toward the sheepskin; the lower the net worth of the parents, the more the kids paid.

That out-of-pocket money has to come from somewhere, and for those 7 percent of families, it came from retirement savings withdrawals, at an average amount of $8,870. In 2013, when 5 percent came from such withdrawals, the amount was much lower, averaging $2,710. Parents are paying in more ways than just the funds lost to retirement: they’re also liable for early withdrawal penalties from 401(k)s, if they’re under 59½, which eats up 10 percent of what they withdraw. Add to that income tax on the money withdrawn and the fact that a withdrawal will often mean the parent can’t contribute again to the plan for at least six months, further impairing his ability to start pushing the balance back up again.

At least with IRAs, there’s no early withdrawal penalty if the money is used for higher education expenses, or room and board for a student attending at least half time.

While neither is good, a loan can be better for the parent than a withdrawal; no taxes are due as long as the loan is repaid with interest within five years, and the balance isn’t permanently damaged as much as from a withdrawal. But if the parent leaves or loses the job and the loan isn’t repaid, the loan becomes a tax-due distribution.

To add insult to injury, taking a distribution from a retirement account can mess up the student’s financial aid, because it counts as income for the parent. And that, in turn, can end up costing the parent more money in the long run, if there’s no other way to cover the additional expense.

Also read: Supporting family members can stall retirement

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