There are many tax-advantaged college savings program that lets you save with after-tax dollars. The popular Section 529 plans, Coverdell education savings accounts and life insurance cash values all compound tax-free when used for qualified higher education expenses. However, if you would like to benefit from pre-tax dollars, you can use IRAs, 401(k)s and other qualified retirement plans. These plans generally allow penalty-free withdrawals for college. Remember, all withdrawals subject to income tax like your regular income for that year.

401(k) Plans

Find out if your 401(k) plan sponsors allow in-service distributions for the purpose of funding education expenses for yourself or family. Check your plan’s rules for specifics or call their support number. If your plan allows, you can withdraw your 401(k) plan penalty free to fund college expenses and pay income tax later like regular income. Your plan administrator may withhold 20 percent from any distributions you take out and forward it to the IRS which you may get it back during tax season. Generally, rules for 403(b) tax-sheltered annuities are similar to those for 401(k) plans. Check your plan sponsor’s rules for specifics.

Traditional IRAs

IRS allows for penalty free withdrawals for “hardship conditions.” for IRAs. Withdrawals to pay college costs for yourself and family qualify. Similar to 401(k) plans, withdrawals are subject to income tax.

Considerations

By using tax-deferred savings vehicle to pay for college, you will lose the benefit of the tax-deferral on those dollars forever. Always use caution against drawing down more from your IRA for college than you can afford. Explore other options like student loans, home equity loans, personal loans or loans against life insurance policies to fund college expenses too. Talk to us to see what is your best option to fund your or loved one’s college.

Tax-Deductible Educational Expenses

Certain education costs are tax-deductible as unreimbursed employee business expenses, or as business expenses on your Schedule C. This allows you to save using pre-tax dollars from your IRA or 401(k) plan, and still pay for the program using essentially pre-tax dollars. You will still have to declare the income you take out of these accounts, but it’s a tax wash — at least to the extent that certain educational expenses are deductible. To deduct educational expenses, however, the education must be for the purpose of enhancing your potential or income in your current profession. Furthermore, the education cannot qualify you for a new profession.