How to Pay for Education Loans with IRA Money

Individual retirement accounts help you accumulate tax-deferred money for use after you reach age 59 ½. You can take money out of your IRA before reaching that age to pay for education loans, but you might be subject to taxes and penalties. In addition, the money you withdraw is no longer available for your retirement, and you lose the tax-deferred earnings it would create.

Money you withdraw from a traditional IRA is treated as ordinary income, meaning you have to pay taxes on it. Furthermore, you must pay a 10 percent penalty if you withdraw the money before age 59 ½. Traditional IRAs do offer some exceptions to the penalty, including using the money for eligible education expenses.

These expenses include the cost of tuition, fees, books, supplies and required equipment. However, the penalty exceptions do not extend to repaying student loans. To withdraw IRA money, fill out the paperwork provided by the account custodian and request either a check or a direct deposit to your checking account. You can use this money for any purpose, but remember that you will be on the hook for taxes and perhaps a penalty payment.

Unlike traditional IRAs, the contributions you make to Roth IRAs are after tax, so different withdrawal rules apply. If you want to withdraw earnings from your Roth, you need to observe two rules in order to avoid taxes and penalties. First, the initial contribution to the Roth must have occurred at least five years ago. There are no exceptions to this rule, and early withdrawal of earnings will produce a tax bill and a 10 percent penalty.

You’ll also owe taxes and a penalty if you withdraw earnings before age 59 ½, but there are exceptions to the penalty. Using the money to repay student loans is not an exception.

You might be able to reduce your need to take out a student loan in the first place by taking advantage of the IRA tuition exception. However, bear in mind that IRA withdrawals applied to eligible costs might reduce the size of a subsidized federal student loan, which is based on financial need.

That need is the difference between the cost of attending school and your expected family contribution, which is the amount the student and her family are expected to kick in. IRA money you withdraw for tuition will reduce the gap between your cost of attendance and the expected family contribution, possibly reducing the size of your federal student loan.

Student loans affect how much IRA money you can withdraw without penalty. The size of the penalty exception for education is based on the year’s eligible education expenses paid by eligible sources, which are wages, a loan, a gift, an inheritance and/or a withdrawal from personal savings for the year.

Tax-free gifts and scholarships are not considered eligible sources. This means that the more you pay for eligible education expenses from eligible sources, the more IRA money you can withdraw without penalty. You can use this withdrawal for any purpose penalty free, including school room and board, as long as the withdrawal doesn’t exceed your eligible education expenses paid from eligible sources.