Debt Free Child, Later Retired Dad
May 1, 2015 5:51 AM Subscribe
I am over 59 1/2 years old. I need to take money out of my IRA for my daughter's last year of college. Help me to find a way to do this with the least tax impact.
Our goal is to get our child through college with no debt. At this point our budgeted college money is gone and I will have to take out around $40,000 out of MY IRA for her last year. $11,000 is in a Roth IRA so that will be the first to go. Then....? I would like my tax impact to be minimum. I am still contributing to my IRA every month. No lectures about how we should have planned better please.
Our goal is to get our child through college with no debt. At this point our budgeted college money is gone and I will have to take out around $40,000 out of MY IRA for her last year. $11,000 is in a Roth IRA so that will be the first to go. Then....? I would like my tax impact to be minimum. I am still contributing to my IRA every month. No lectures about how we should have planned better please.
Has your family completed a FSFA? If you can get a Federal loan, they are cheap and fixed rate and tax deductible. Generally this will work out better than raiding your IRA at 60 (and potentially you can pay the balance of the loan off at retirement.)
posted by DarlingBri at 6:10 AM on May 1, 2015 [1 favorite]
posted by DarlingBri at 6:10 AM on May 1, 2015 [1 favorite]
Response by poster: Please, no lectures. We have done a FSFA every year and were not eligible for anything but loans. We will not borrow to finance her education although I am open to borrowing against my IRA.
posted by Xurando at 6:21 AM on May 1, 2015
posted by Xurando at 6:21 AM on May 1, 2015
You're trying to take care of your daughter, which is awesome. But consider this - are you trading a debt-free life for her right now for the later-in-life burden of parents who can't afford to retire without her help later? Paying off a $40k loan with a decent job is not hard for a young earner, and can be done in a couple of years with a little discipline - which is GOOD for kids starting out. Paying for assisted living for destitute parents in your forties and fifties is a decade or more of sadness, frustration and financial stress, just when you should be hitting your stride in life.
Unless you're really, really well set up for retirement right now, you're shortchanging your future 40-year-old daughter, who will be trying desperately to make sure you're safe and well-cared for with her own money instead of what you saved for retirement. Take it from a forty-year-old daughter currently in therapy to help deal with this very issue.
That said, this is a great question for the r/personalfinance crowd on reddit. They'll be able to tell you your tax impact down to the dime if you need it.
posted by kythuen at 6:29 AM on May 1, 2015 [11 favorites]
Unless you're really, really well set up for retirement right now, you're shortchanging your future 40-year-old daughter, who will be trying desperately to make sure you're safe and well-cared for with her own money instead of what you saved for retirement. Take it from a forty-year-old daughter currently in therapy to help deal with this very issue.
That said, this is a great question for the r/personalfinance crowd on reddit. They'll be able to tell you your tax impact down to the dime if you need it.
posted by kythuen at 6:29 AM on May 1, 2015 [11 favorites]
Inquiring whether you've done an FSFA is not lecturing, you didn't supply that information.
There is no easy way to do this. Every dollar you take out of your IRA will increase your taxable income for that year, and potentially put you into a higher tax bracket. Even without bumping you up, chances are you are in the 25% tax bracket; ie., any incremental dollar is taxed at 25%. So if you withdraw $40,000, whether you spread it over one year or two years, you'll pay $10,000 in taxes on it. If you need $40,000 net, you'll have to withdraw $52,500. If your IRA is making, say, 6% annually, that $52,500 would grow to $94,000 in 10 years time. So the real impact on your net worth, 10 years out, by withdrawing, is $94,000.
If you're OK with that impact, that's the way to go. But if I were staring at a $94,000 impact 10 years out, I'd be looking at the various low-cost loan options. Assume that you repay loans by reducing your IRA payments. Calculate what those foregone IRA contributions would add up to, with interest, in 10 years. That's the net worth impact of borrowing, and it is bound to be less than $94,000 unless your borrowing interest rate is sky-high for some reason.
Borrowing against your IRA is not a good idea. The IRA treats the loan as a withdrawal and will charge you taxes on it. If you can, borrow against your home equity (on which interest payments will be deductible) or get the federal student loan with deductible interest. Either one should be available for 5% or less.
posted by beagle at 6:31 AM on May 1, 2015 [6 favorites]
There is no easy way to do this. Every dollar you take out of your IRA will increase your taxable income for that year, and potentially put you into a higher tax bracket. Even without bumping you up, chances are you are in the 25% tax bracket; ie., any incremental dollar is taxed at 25%. So if you withdraw $40,000, whether you spread it over one year or two years, you'll pay $10,000 in taxes on it. If you need $40,000 net, you'll have to withdraw $52,500. If your IRA is making, say, 6% annually, that $52,500 would grow to $94,000 in 10 years time. So the real impact on your net worth, 10 years out, by withdrawing, is $94,000.
If you're OK with that impact, that's the way to go. But if I were staring at a $94,000 impact 10 years out, I'd be looking at the various low-cost loan options. Assume that you repay loans by reducing your IRA payments. Calculate what those foregone IRA contributions would add up to, with interest, in 10 years. That's the net worth impact of borrowing, and it is bound to be less than $94,000 unless your borrowing interest rate is sky-high for some reason.
Borrowing against your IRA is not a good idea. The IRA treats the loan as a withdrawal and will charge you taxes on it. If you can, borrow against your home equity (on which interest payments will be deductible) or get the federal student loan with deductible interest. Either one should be available for 5% or less.
posted by beagle at 6:31 AM on May 1, 2015 [6 favorites]
You need to consult with a tax professional like an accountant or a tax lawyer. You're asking for legal advice about tax issues. But I will say, you could take out a student loan and then when you can withdraw from your IRA without penalty in a few years, pay it off, and have the benefit now of your retirement funds continuing to grow and not having to worry about a penalty.
For what it's worth, I suspect that failing to adequately fund your retirement is a worse idea than your kid having to take on some student loan debt, especially if they're smart about minimizing it.
posted by J. Wilson at 6:32 AM on May 1, 2015 [5 favorites]
For what it's worth, I suspect that failing to adequately fund your retirement is a worse idea than your kid having to take on some student loan debt, especially if they're smart about minimizing it.
posted by J. Wilson at 6:32 AM on May 1, 2015 [5 favorites]
Take out a loan for your daughter, pay for her college, then pay off the loan 100% from your retirement funds as soon as you can withdraw from your IRAs without paying a penalty.
posted by alms at 6:36 AM on May 1, 2015 [13 favorites]
posted by alms at 6:36 AM on May 1, 2015 [13 favorites]
OP, the answer to this will depend on a lot of factors like how close you are to the next marginal tax rate, when the money is due, etc. So I think the best answer is to talk to a tax professional.
and then when you can withdraw from your IRA without penalty or tax consequences in a few years
If this is a traditional IRA, which I assume it is, given that the OP says they will draw $11K from their ROTH first -- there is no age at which you don't pay taxes on withdrawals from a trad IRA. You probably will pay less in taxes if you withdraw in retirement, since you're not earning a salary in retirement and that money will likely fall in a lower tax bracket, but the Feds still get their share, whether from you (when you make qualified withdrawals or when they start requiring you to take distributions at 70 1/2) or from you heirs (who will have withdrawal requirements of their own).
Also, OP is already past the early withdrawal penalty age, so that's not relevant here.
posted by pie ninja at 6:41 AM on May 1, 2015 [1 favorite]
and then when you can withdraw from your IRA without penalty or tax consequences in a few years
If this is a traditional IRA, which I assume it is, given that the OP says they will draw $11K from their ROTH first -- there is no age at which you don't pay taxes on withdrawals from a trad IRA. You probably will pay less in taxes if you withdraw in retirement, since you're not earning a salary in retirement and that money will likely fall in a lower tax bracket, but the Feds still get their share, whether from you (when you make qualified withdrawals or when they start requiring you to take distributions at 70 1/2) or from you heirs (who will have withdrawal requirements of their own).
Also, OP is already past the early withdrawal penalty age, so that's not relevant here.
posted by pie ninja at 6:41 AM on May 1, 2015 [1 favorite]
What about the gift laws? Don't forget you can give up to 14k away. Not sure how that works with Qualified money, so ask your tax specialist.
posted by Gungho at 7:02 AM on May 1, 2015
posted by Gungho at 7:02 AM on May 1, 2015
One of my friend's (and his parents) were in a similar situation, and what they ended up doing was taking out student loans at good rates, but then the parents paid for the loans entirely. This had a few good points -- no tax penalty for the retirement funds, reasonable interest rates (although you'd have to see what these are now -- I think things maybe aren't as good these days as they were when I was in school, but I think you still come out ahead of the tax penalty), PLUS it was building their son's credit. Regular student loan payments are actually a great way to build credit as a young person. Of course, I also don't think there's anything terribly wrong with your daughter paying off some portion of the loans herself (plenty of people go that way), but even if you want to committ to fully paying your daughter's college costs (which is awesome and admirable), I think the way to do it is loan + you pay off the loan.
posted by rainbowbrite at 7:05 AM on May 1, 2015 [6 favorites]
posted by rainbowbrite at 7:05 AM on May 1, 2015 [6 favorites]
Taking traditional finance off the table is effectively saying you'd rather pay more to the government in the short-term than less to an agency/bank in the longer term. It sounds ideological, but financially it's not a sensible solution.
This.
However, if you must explore other options:
1. Take money out of the Roth IRA last. The advantage of the Roth is that you've already paid the taxes on it but it needs time to grow, the longer, the better. It also has no minimum required distributions and has potential benefits if you can pass it onto your daughter as part of your estate compared to a traditional IRA.
2. You generally can't borrow from/against your IRA but you can do so with your 401(k), if you have one, but it will lock you into your current employer until it's paid back.
3. If you have a paid off house or car, it would be better to take out a loan against them, given the extremely low interest rates at this time.
posted by Candleman at 7:10 AM on May 1, 2015 [1 favorite]
This.
However, if you must explore other options:
1. Take money out of the Roth IRA last. The advantage of the Roth is that you've already paid the taxes on it but it needs time to grow, the longer, the better. It also has no minimum required distributions and has potential benefits if you can pass it onto your daughter as part of your estate compared to a traditional IRA.
2. You generally can't borrow from/against your IRA but you can do so with your 401(k), if you have one, but it will lock you into your current employer until it's paid back.
3. If you have a paid off house or car, it would be better to take out a loan against them, given the extremely low interest rates at this time.
posted by Candleman at 7:10 AM on May 1, 2015 [1 favorite]
OP is not talking about gift tax which is a completely separate thing and doesn't have to do with paying income tax on money you pull out of an IRA. Also, money spent on tuition is not subject to the gift tax.
OP, I really think you need to discuss with a tax professional if you are 100% committed to pulling from your IRA rather than borrowing. But I agree with buoys in the hood that borrowing may be a much better option for you.
posted by pie ninja at 7:15 AM on May 1, 2015 [1 favorite]
OP, I really think you need to discuss with a tax professional if you are 100% committed to pulling from your IRA rather than borrowing. But I agree with buoys in the hood that borrowing may be a much better option for you.
posted by pie ninja at 7:15 AM on May 1, 2015 [1 favorite]
nthing buoys in the hood: you're asking for the best way to minimise an ideological penalty that you're imposing on yourself, and the penalty's not one of competing interest rates, but rules set by the IRS. If you're intent upon it, then you'll want advice from a professional who has full view of your finances.
Qualified student loan interest is tax deductible within limits. If you have home equity and aren't at risk of being underwater, then even a HELOC might be a better option here.
posted by holgate at 7:40 AM on May 1, 2015 [1 favorite]
Qualified student loan interest is tax deductible within limits. If you have home equity and aren't at risk of being underwater, then even a HELOC might be a better option here.
posted by holgate at 7:40 AM on May 1, 2015 [1 favorite]
Response by poster: This is not a simple problem. I am not putting my exact age on AskMe but most of my friends my age are retired now.I still work. My wife's parents paid for our daughters first two years of school. My wife paid for last year. She says it's my turn now. She actually has 150% more retirement money than I do.Between us we'll be set when she retires but I.m not. She is adamant about not borrowing and to some extent so am I. I am definitely a you can't take it with you person and have no expectations of my child that she is responsible for me later. My wife's parents paid for her school. I got no help at all. No debt is important. I will be talking to both my accountant and the financial planner holding my money but I wanted to check with AskMe first.
posted by Xurando at 7:54 AM on May 1, 2015
posted by Xurando at 7:54 AM on May 1, 2015
If you truly do not want your daughter to have any debt, I'd consider a HELOC if that's an option, or a parent Plus loan and cut your retirement contributions this year. I borrowed all the way through and my parents made up the difference between my scholarships+loans and tuition by taking out a HELOC.
posted by notjustthefish at 8:28 AM on May 1, 2015 [2 favorites]
posted by notjustthefish at 8:28 AM on May 1, 2015 [2 favorites]
Mod note: This is an answer from an anonymous commenter.
I'm the child of parents who paid cash for her undergraduate education and also can't afford to retire. They don't expect me to help them, but they raised me to take care of my responsibilities. I would rather have a student loan payment than worry than watch my parents continue to work well past the point where they're really capable of working, because they can't afford to retire. I try to help them out when I can, but assume that I will be largely responsible for one or both of their welfare sooner than I can afford it. Please seriously reconsider this approach, regardless of what your wife's opinion is.posted by cortex (staff) at 8:33 AM on May 1, 2015 [19 favorites]
Best answer: I have been in the same boat as you. I used IRA's to finance kids college and also pay huge out-of-pocket costs for my knee replacements. I've talked to tax pros, and I don't think there is any way to escape the tax burden.
posted by nogero at 8:45 AM on May 1, 2015
posted by nogero at 8:45 AM on May 1, 2015
No debt is important
Is it "pay an extra $30k" important? If not, yeah, go with your plan.
If you'd like to pay the minimum, have her take the loans and you pay them off. Modify your will so she is made whole if you die before paying off her loan.
Stupid debt is bad. Smart debt is good. Stupid debt is borrowing money you and her can't pay back. This is smart debt.
posted by flimflam at 8:49 AM on May 1, 2015 [2 favorites]
Is it "pay an extra $30k" important? If not, yeah, go with your plan.
If you'd like to pay the minimum, have her take the loans and you pay them off. Modify your will so she is made whole if you die before paying off her loan.
Stupid debt is bad. Smart debt is good. Stupid debt is borrowing money you and her can't pay back. This is smart debt.
posted by flimflam at 8:49 AM on May 1, 2015 [2 favorites]
Stupid debt is bad. Smart debt is good.
There are very few forms of debt where the IRS throws you a bone. Student loans and mortgage loans are among them. Drawing large chunks of cash from your retirement savings is throwing a bone at the IRS.
Given your replies, this is more of a relationship question than a financial question: to the extent that it's financial, you can fulfil your perceived obligations to your daughter in ways that don't create a rod for your own back.
posted by holgate at 9:21 AM on May 1, 2015 [2 favorites]
There are very few forms of debt where the IRS throws you a bone. Student loans and mortgage loans are among them. Drawing large chunks of cash from your retirement savings is throwing a bone at the IRS.
Given your replies, this is more of a relationship question than a financial question: to the extent that it's financial, you can fulfil your perceived obligations to your daughter in ways that don't create a rod for your own back.
posted by holgate at 9:21 AM on May 1, 2015 [2 favorites]
I am over 59 1/2 years old... I will have to take out around $40,000 out of MY IRA for her last year. $11,000 is in a Roth IRA so that will be the first to go. Then....? I would like my tax impact to be minimum. I am still contributing to my IRA every month.
Okay, setting aside all the alternative approaches which you've rejected, if the question is simply "how to minimize the tax burden" I believe the answers are:
posted by alms at 12:08 PM on May 1, 2015 [1 favorite]
Okay, setting aside all the alternative approaches which you've rejected, if the question is simply "how to minimize the tax burden" I believe the answers are:
1. move to New Hampshire, Washington, or another state that doesn't have an income tax before making the withdrawal.An accountant or financial advisor may have additional suggestions for lower the tax impact of the withdrawal.
2. reduce your income for the year enough to lower your tax bracket.
posted by alms at 12:08 PM on May 1, 2015 [1 favorite]
Have you considered borrowing from your own retirement account? You can borrow up to $50,000 and pay it back over 5 years. This will not be subject to federal taxes.
If you take the money out of the account, the amount will be added to your income for the year it is withdrawn. It will be added to your taxable income (and might push you into a higher tax bracket to boot. I know this from personal experience, and I wasn't expecting to take the hit I took). If you and your wife file together, this will affect her taxes, too. It's possible you could soften this particular blow by dividing your withdrawals over two tax years, since this is to pay for a single academic year. I suggest you consult your accountant or financial planner, as this is a pretty common scenario.
posted by citygirl at 1:50 PM on May 1, 2015
If you take the money out of the account, the amount will be added to your income for the year it is withdrawn. It will be added to your taxable income (and might push you into a higher tax bracket to boot. I know this from personal experience, and I wasn't expecting to take the hit I took). If you and your wife file together, this will affect her taxes, too. It's possible you could soften this particular blow by dividing your withdrawals over two tax years, since this is to pay for a single academic year. I suggest you consult your accountant or financial planner, as this is a pretty common scenario.
posted by citygirl at 1:50 PM on May 1, 2015
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