e recently received a question from a listener. Jim asked, “I recently changed jobs and have a retirement plan from my former employer. I want to use part of that money to pay for my son’s college expenses. What is the best way to do that?”

In this clip, we talk about the potential lost opportunity of compounded returns for your retirement.

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As the cost of college education rises every year, parents and students alike seek ways to fund the expense. One approach that some families take is to tap into their retirement savings, such as a 401(k) or IRA, to cover tuition and other costs. However, while it may seem like a good idea at first, using a retirement plan to pay for college could end up costing a whole lot more than just paying the taxes.

The first thing to understand is that withdrawals from a retirement account before age 59 and a half are subject to both income taxes and a 10% penalty. So, if you withdraw $50,000 from your 401(k) to pay for your child’s tuition, you’ll have to pay taxes on that amount at your current tax rate, plus an extra $5,000 penalty. That can significantly reduce the amount of money you have available for retirement.

Secondly, taking money out of a retirement account means missing out on the potential growth those funds could have earned. Retirement accounts are designed to grow over time, with contributions and investment earnings compounding tax-free. By taking money out to pay for college, you’re essentially forfeiting that growth, which can have a long-term impact on your retirement savings.

Finally, using a retirement plan to pay for college could also have unintended consequences for financial aid eligibility. Colleges consider both the student’s and parents’ income and assets when determining financial aid eligibility. Retirement accounts are usually not counted as an asset, so leaving the money in the account could help maximize financial aid awards. However, if you withdraw money from the account to pay for college, that money will be counted as income for the year, potentially reducing the amount of financial aid your child qualifies for.

In conclusion, while using a retirement plan to pay for college may seem like a quick fix, it can have significant drawbacks. Not only are you likely to incur hefty taxes and penalties, but you’re also sacrificing potential growth and potentially affecting financial aid eligibility. Before tapping into your retirement savings, explore other options such as scholarships, grants, and student loans. And if you do decide to withdraw money, consult with a financial advisor to understand the full impact on your retirement plans.