Dear Dr. Don,
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What is the current rate on a home equity loan of $50,000 with an excellent credit score? We have no debt other than a mortgage for the next 11 years. I need to pay for four more semesters of college costs for a student. What would the penalty be for taking money out of a retirement account?
You lose when you raid retirement accounts for higher education expenses, because money you were saving for retirement ends up somewhere else. And, you lose when you tap your home's equity to pay college costs because you're further away from paying off your home.
With an excellent credit score, you should be able to get a home equity loan for $50,000 with an interest rate of 6.14% or a home equity line of credit with an initial interest rate of 4.99%. These are Bankrate's reported national averages as I write this reply. Depending on the terms of your existing first mortgage, and closing costs, a cash-out mortgage refinancing may be a better approach than using a home equity line or loan.
Raiding your traditional individual retirement account before age 59 1/2 for qualified higher-education expenses is one of the approved exemptions from the 10% additional tax. That's true for the Roth IRA, too, but since Roth IRAs are funded with after-tax dollars, the concern surrounds the taxability of the Roth IRA investment earnings. Roth IRAs also have an account seasoning requirement of five years in order for distributions to be considered qualified.
If you're taking money out of tax-deferred retirement accounts, you would owe income taxes whenever you take a distribution. It is not an additional tax that is due. Instead, you bring the tax bill forward by taking the distribution early. If you are in a higher tax bracket now than you expect in retirement, you're paying taxes at a higher rate. If you're in the 20% marginal federal income tax bracket now and you expect to be in the 15% bracket in retirement, then you're paying an additional 5% in taxes.
Taking money out of your retirement accounts or tapping the equity in your home might also result in reduced financial aid packages for the college student.
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