Tap an IRA for Your Child's College?

Dear Dr. Don,

If we take money out of our retirement account to finance our daughter's college tuition, will we lose out on financial aid for next year? Also, will I be taxed on the amount taken out? How will this affect our income taxes next year?

- Marcel Matriculate

Dear Marcel,

When you withdraw money from a traditional individual retirement account, or IRA, to finance your daughter's college tuition, it does count as income when your daughter files her Free Application for Federal Student Aid, or FAFSA, for the next academic year. Because of this, it makes the most sense to take distributions from a traditional IRA in the student's senior year.

You'll pay income tax on the distributions, presuming the contributions were made with pretax dollars, although distributions made for qualified higher education expenses aren't subject to the 10 percent penalty tax charged account owners for distributions made before the account holder turns 59½.

You can borrow from a 401(k) plan and the loan won't count as income, and you won't owe a penalty tax or taxes on the loan. The downside with a plan loan is that it becomes due immediately if you leave the job.

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