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Can I Use My IRA To Pay Off Student Loan Debts?

It is quite expensive to attend school. Taking out a student loan is the only option.

However, taking on that much debt means you’ll have to stick to a payback schedule.

Paying off your student loans can take anything from 10 to 30 years. Of course, how much you borrow and whether you have a normal or income-driven repayment plan will determine this.

You might be wondering if you can pay off your student loans faster.

The first thing to understand is that, yes, you can use your IRA to pay off student loan debts.

In this article, we’ll look at how you can pay down your student debts with an IRA. As we’ll see, this method has several potential advantages and disadvantages.

Is It Possible to Pay Off Your Student Loans With an IRA?

So, can you pay off your student loans using your IRA? Yes, but there are some key considerations to consider.

This includes, but is not limited to, your age and the sort of IRA you have.

If you have a Roth IRA, for example, you must consider how long you’ve had the account.

You can withdraw cash from a typical IRA to pay off your student loans at any point if you are 59 or older.

If you are under the age of 59½, you can still utilize traditional IRA assets to pay for student loans, but your withdrawals will almost certainly be subject to both income tax and early-withdrawal tax penalties.

To put it another way, student loans are not an excluded reason for taking an early withdrawal from your retirement account.

Direct higher education expenses, such as tuition, administrative fees, books, and school supplies, may be eligible for an exempt early withdrawal.

You can take money out of a Roth IRA at any time without incurring penalties. You cannot, however, withdraw any money you have earned. To take earnings from those payments without penalty, you must wait until you turn 59½.

If you’ve had the Roth IRA for at least 5 years when you reach that age, you can withdraw the money tax-free.

Early Distribution Tax Penalty

To discourage early withdrawals from IRA accounts, the IRS charges a 10% tax penalty on any taxable assets withdrawn before the account owner reaches the age of 59½.

This penalty is in addition to any income tax owed on IRA distributions.

When you remove $10,000 in taxable assets from your IRA to pay off loans before reaching retirement age, your effective tax rate is %32.

You will owe taxes on $3,200 of the $10,000 you withdraw.

The Roth IRA Benefits

Early withdrawals from a regular IRA are normally taxed and penalized unless you make after-tax contributions.

Non-deductible contributions, on the other hand, account for a portion of your balance and are not paid out in any particular order, so at least a portion of your payout is taxed.

Roth IRA contributions and withdrawals are less likely to be taxed or penalized, regardless of your age, because you paid income tax on them when they were earned and deposited.

Because Roth account contributions are always made after-tax money, a person can withdraw their direct contributions at any time, in any quantity, and for any reason.

Taxation and penalties apply only to the portion of an early withdrawal that is derived from earnings.

Roth IRA contributions are always allocated before earnings.

Because of this, if your student loan outstanding amount is less than or equal to the amount you contribute to a Roth IRA before retirement age, you may pay off your loans tax-free.

More: Refinance My Home to Pay Off Student Loans: Is It Make Sense?

Paying off Student Loans by Using a 401 (k)

A 401(k) is identical to an IRA, except that it is provided by your employer.

Some firms provide both standard 401(k)s and Roth 401(k)s, in which you contribute pre-tax dollars and after-tax cash.

If you take money out of a regular 401(k) before turning 59½, you’ll face a 10% penalty plus income tax.

You can borrow a 401(k) loan in some 401(k) programs. 401(k) loans have low-interest rates, making them a very reasonable borrowing alternative.

You’ll miss out on possible retirement fund gains.

Furthermore, taking out a 401(k) loan can be dangerous since if you leave your job while still paying off your loan, you’ll be required to repay it promptly and in full.

If you can’t pay it back, it will be considered an early withdrawal and may incur taxes and expenses.

How Much Will It Cost You to Use Your IRA to Pay Off Student Debt?

Borrowing from your retirement savings early may not only cost you a significant sum in taxes and penalties, but it may also cost you earnings that you would have received had you left the money in your account.

Assume your regular tax rate is 24%. You’ll effectively be paying %34 of your payout if you pay the 10% penalty on an early withdrawal.

You’ll incur $3,400 in taxes and fees if you took $10,000 out of your IRA to pay off your student loans early.

Furthermore, your retirement plan’s custodian may automatically deduct 20% to meet taxes.

While you may receive some of this money back during tax season, you can expect it to be kept back.

Rather than taking the full $10,000 upfront, you may only receive $8,000 now.

And if you make a large withdrawal, you might be pushed into a higher tax class, in which case you’ll pay even more taxes than usual.

As a result, you might only earn $8,000 upfront instead of the entire $10,000.

Furthermore, if you make a very big withdrawal, you may be moved into a higher tax category, resulting in higher taxes than usual.

Let’s pretend you put $10,000 into your retirement savings account.

After 10 years, you’d have around $19,672 in your account if you earned a 7% annual rate of return. You’d have $38,697 in your account after 20 years.

This assumes you don’t make any more IRA or 401(k) contributions.

If you continue to save, compound interest will enable you to earn even more money in your retirement account.

You may also like: Student Loan Refinance Calculator – Should You Refinance?

Better Alternatives of Using your IRA to Pay off Student Loan Debts

The costs of using your IRA to pay off student loans may outweigh the benefits.

You will have to consider not only taxes and fees, but you may also miss out on potential earnings from investing your money.

There is a penalty-free method to use your retirement funds to pay for your education, whether you have a regular IRA.

When making IRA withdrawals for qualified education expenses, the penalty is not charged.

While your withdrawal cannot exceed your current year’s entire education expenditures, it may be used to pay a variety of fees.

Tuition, books, accommodation and board, fees, equipment and supplies, and special needs services are all eligible expenses.

The loan repayment for a student loan is not an eligible educational expenditure.

Even though you don’t have to pay income tax on your traditional IRA distribution, you must still pay taxes on any taxable portion of it.

In this case, all Roth IRA payouts, whether they are contributions or earnings, are tax-free and penalty-free.

The IRS allows you to deduct your tuition, fees, and other educational expenses for yourself, your spouse, your children, and their descendants.

For college students without significant retirement assets, quitting work to focus on their education is adream.

However, people who pursue further study after they’ve graduated can greatly profit.

Think About Refinancing Your Student Loans

If you can save money by refinancing, it’s a good idea, but it’s not for everyone.

If you have decent credit and wish to refinance your student loans, check the rates and terms offered by several lenders (or accept a cosigner).

You can consolidate many loans into one when you refinance to make repayment easier.

Find lenders willing to offer you a lower interest rate. Compare and contrast them.

On the other side, refinancing federal student loans is not advised since it makes them private loans that are not eligible for income-driven repayment plans or forgiveness programs.

Maybe you’re wondering if refinancing your student debts will cost you anything. There is no charge for refinancing your student loans.

Bonus: Compare The Best Refinancing Lenders in 2022

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Seek a Deferment or Forbearance

Deferment or forbearance is another option for federal and some private student loans.

Both of these choices allow you to temporarily suspend your loan payments if you’re having financial difficulties, have returned to school, or have another eligible cause.

The disadvantage of deferring your loan payments is that your debt will almost certainly increase due to interest charges.

Only subsidized loans, which do not accumulate interest during deferment, are an exception.

For all other loan kinds, however, deferring or forbearing payments may be a temporary fix rather than a long-term solution.

Frequently Asked Questions