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Considerations Before Using an IRA to Pay Off Your Student Loans

Considerations Before Using an IRA to Pay Off Your Student Loans
Brian O'Connell
Brian O'ConnellUpdated November 21, 2022
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Individual retirement accounts, or IRAs, aren’t the first thing that comes to mind when mulling over student loan repayment options. After all, retirement planning experts routinely advise against raiding retirement plans to cover other costs.Does that mean you should never consider using an IRA to pay student loans off? While you can use an IRA to pay off student loans, you’ll want to look at other options first and ensure that you understand the drawbacks of tapping your retirement plan to pay back student debt.

What Are Your Reasons for Paying Off Your Student Debt?

Before considering using an IRA to pay off student loan debt, you’ll first want to establish your reasons for paying down college loan debt. Knowing the “why” for covering student loan debt can help you determine whether using your IRA to pay off student loans is worth it to you.

You Want to Lower Your Debt-to-Income Ratio 

One potentially good reason to get a jump on paying off your student loan debt is to lower your debt-to-to-income ratio, which represents the percentage of your monthly income that goes toward paying your debts each month. A lower debt-to-income ratio can make it easier to get approved for new credit, whether that’s a mortgage or a car loan. That’s because having a lower debt-to-income ratio signals to borrowers that you have your debt load under control and aren’t in over your head.

The Debt Feels Like a Burden 

High student loan debt can feel like an emotional drain on a borrower, especially given the rising cost of college over time. Addressing it and paying it off can take that stress away. However, you’ll want to make sure that alleviating financial stress now won’t cause you to simply feel that stress later, such as by being unprepared for retirement.

You Can’t Afford to Make Your Monthly Loan Payments

Maybe you’re unemployed or under-employed, or you’re ill or injured, and you just can’t meet your monthly student loan debt obligations. In that scenario, finding another solution to get ahead of those debt payments is an understandable desire.

You Have Many Loans and Can’t Manage All the Different Payments

It’s all too common to have different loans for your house and your car, not to mention credit card debt and student loan debt, among any other debt obligations. Juggling all those monthly bills and their varying due dates isn’t necessarily easy. By eliminating your student loan bill, you could take one debt off your plate.

Can You Tap Other Funds to Pay Off Your Student Loans?

Before turning to your IRA — a tax-advantaged fund intended for retirement — it’s worth considering if there are any other areas you could tap to pay off your student loans.Maybe by assessing your monthly budget, you’ll find that there are a number of areas in which you could cut back. You could then use those savings to make extra payments toward your student loan debt each month.Another option might be sitting right there in your bank account. If you already have a sizable emergency fund and have savings to spare, you could repurpose some of that money toward student loan debt repayment. You won’t owe a tax penalty on those funds like you would with an IRA withdrawal.You might also look into grants that are available to help pay off student loans. There are a number of grants offered to those in certain professions, and some companies even help their employees to pay off student loan debt. Check into what options might be available to you, and see if you meet the requirements to apply.

Have You Looked Into Other Solutions?

It’s perfectly reasonable to make your student loan debt a household budget priority, but that doesn’t mean you need to jump straight to your IRA to handle that debt. Before you consider any college loan repayment options, contact your student loan servicer as soon as possible if you’re having trouble paying any loan debt. Student loan companies likely will work with you if you let them know you need help — you just have to ask.Additionally, there are a number of other potential student loan repayment options that you might consider exploring, from income-driven plans to consolidation. 

Income-Driven Plans

Student loan income-driven repayment plans enable you to make your monthly student loan payment based on your income and family size. This can make loan repayment much more affordable and manageable within your budgetary constraints.There are four different income-driven repayment plans available that can cap your monthly loan payments to 10%, 15%, or 20% of your discretionary income. The plans can also stretch out your loan term, which will further lower monthly payments (though that may increase the amount of interest you pay over time). If you have any balance remaining at the end of your term, that amount will be forgiven.

Refinancing

If the interest rate on your student loan is high, especially compared to current interest rates, you can refinance your student loan. Ideally, you’ll be able to secure a new loan with a lower interest rate or better terms, which may lower your monthly loan payments.Do note, however, that refinancing isn’t offered through the federal government. You’ll have to go through a private lender and meet the lender’s credit and income requirements. Refinancing will also result in losing access to federal loan forgiveness programs and repayment plans. In other words, it’s important to weigh the pros and cons of student loan refinancing before moving forward.

Consolidating

If you’re juggling multiple federal student loans, consolidating them through the Department of Education can make your student loan debt easier to manage. Once you consolidate, you’ll have only one loan to pay off. You can also lower your monthly payments, as student loan consolidation allows you to extend your loan repayment term (though a longer term does translate to paying more in interest over the long run). Additionally, you can gain access to more repayment options.Keep in mind, however, that loan consolidation is only available for federal loans. Consolidation may also cause you to lose certain borrower benefits like interest rate discounts, as well as credit for payments made toward income-driven repayment plans or Public Service Loan Forgiveness. 

Cashing Out Your IRA as Last Resort

If you’ve tried all of the above student loan repayment relief options and had no luck, then — and only then — should you consider turning to your IRA.An IRA is a last resort because it isn’t intended as a student loan repayment solution — rather, it’s a tax-advantaged account intended to help save for retirement. You contribute pre-tax money to a traditional IRA, and then pay income tax when you withdraw your funds. When you withdraw your funds before the age of 59 ½ (i.e., before retirement), you’ll not only pay those taxes, but you’ll also typically get hit with an early withdrawal penalty. This penalty is 10% on early withdrawals of taxable funds, which can definitely cut into how much of your IRA funds you end up putting toward student loan debt repayment.A student loan borrower contemplating using their IRA should compare the cost of the early withdrawal penalty and taxes against the cost of student loan interest that accrues over time. They might find that using an IRA to pay off student loans isn’t worth it.

Costs of Using a Traditional IRA to Pay for Student Loans

As mentioned, using an IRA to pay student loans isn’t a cost-free option. You’ll face both taxes and an early withdrawal penalty, and you’ll also lose out on tax-sheltered earnings and funds intended for your eventual retirement.

Taxes

When you withdraw money from a traditional IRA, you’ll owe taxes. IRA withdrawals are taxed as regular income, and your rate is based on your tax bracket in the year in which you make the withdrawal.

10% Early Withdrawal Penalty

If you’re not yet 59 ½, you’ll owe an early withdrawal penalty on top of the income taxes you pay. This penalty is 10% of the amount taken out of the account, unless you qualify for an exception. This could include disability, medical reasons, or getting called to duty as a military reservist.

Loss of Tax-Sheltered Earnings

A traditional IRA offers a number of tax benefits. Specifically, an IRA allows your assets to grow tax-deferred, and you may be able to deduct your contributions from your federal taxes. By cashing out to pay off your student loans, you’ll lose those perks.

Less Funds for Your Retirement

While your golden years may seem far away, it can take a while to save up for a comfortable retirement. Plus, by using your IRA to pay off student loans, you’re not only taking out the contributions you’ve made — you’re also seizing on any growth that can result from compounding interest.Consider whether backtracking on the work you’ve already done to get retirement-ready is worth it to pay off your remaining student loan debt. 

How Roth IRAs Are Slightly Different

One possible solution to paying off student loan debt with retirement account funds is to leverage a Roth IRA, rather than a traditional IRA. This type of IRA allows account holders to withdraw contributed cash (but not earnings) without facing an early withdrawal penalty under certain circumstances. Plus, because you’ve already paid taxes on the money in the account, you won’t owe taxes upon withdrawal.That being said, if you attempt to withdraw Roth IRA earnings (i.e., the money you’ve made on your IRA fund investments), the IRS will levy a 10% penalty on the cash amount withdrawn. That portion is also subject to taxation.On the upside, if you’re 59 ½  and wish to withdraw cash (contributions and earnings) from a Roth IRA, you can do so as long as you’ve held the account for five years.Keep in mind that while you can use Roth IRA to pay student loans at less of a cost compared to a traditional IRA, you’ll still be missing out on future earnings. You’ll also have less funds for your future retirement.

Talking to a Financial Advisor 

If you’re really not sure about the next step to take and how to order your financial priorities, it might be helpful to turn to a professional. A financial advisor can help you evaluate your current financial situation and plan for the future. That way, you can ensure that any decisions you make now don’t end up hurting you down the road. 

The Takeaway 

There’s no shortage of downsides when taking money out of an IRA to pay down student loans. Aside from the money lost in IRS early withdrawal penalties, you’re also losing money that would have benefited from compound interest over the long haul if the cash had remained in your IRA.If you do decide to take cash out of an IRA to cover college loans, discuss your withdrawal options with a trusted financial advisor who can lay out the facts so you make a fully formed decision. After all, money taken out of a retirement account can really never be replaced — not when the original funds could have been earning compound interest.That’s a consideration that should be taken to heart with any IRA withdrawal, even if it would help you pay off your student loans.  

3 Student Loan Refi Tips 

  1. Once the pandemic-related pause on federal student loan payments ends, going back to making payments may be hard on budgets. One solution is to refinance to a lower interest rate, longer loan term, or both, depending on your situation. (The tradeoff is that you’ll be forfeiting federal benefits such as repayment programs.) Find and compare your student loan refinance options.
  2. One pain-free way to pay down your student loan sooner: send in your tax refund to put against the principal balance. Since it’s money that has already been taken out of your pay, you won’t miss it.
  3. If you teach full-time for five complete and consecutive academic years in a low-income school, you may be eligible for federal student loan forgiveness.

Frequently Asked Questions

What are the downsides of using an IRA to pay off student loans?
Can you use your IRA to pay off education expenses without penalties?
Should you prioritize investing or paying off student loans?
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
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About the Author

Brian O'Connell

Brian O'Connell

Brian O’Connell is a freelance writer based in Bucks County, Penn. A former Wall Street trader, he is the author of the books CNBC's Creating Wealth and The Career Survival Guide. His work has appeared in multiple media platforms, including TheStreet.com, Bloomberg, CBS News, Yahoo Finance, and U.S. News & World Report.
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