This week, Gail advises a reader who wants to use funds from her 401(k) to pay for college, and has a few ideas on how to avoid paying the 10% penalty if you really, really have to tap your IRA money.

Hi Gail,

I am finishing my BS degree at a private university. As tuition is extremely expensive, I find that I need to withdraw funds from a 401(k)/IRA. I do not wish to incur tuition loans. Additionally, I wish to also withdraw funds to purchase a home. I am a first time home-buyer. My question is, will the penalty tax be imposed on the full amount I plan to withdraw, about $25,000? Thank you!


Rita, Rita, Rita!!!

You DO NOT want to do this! First of all, the interest rate on student loans right now is the lowest it has been in 40 years. For details, check out the article I wrote on this in August.

Second, there are different rules that cover withdrawals from 401(k)s and IRAs. For instance, you cannot simply take money out of your 401(k) just because you want it. If -- and I must stress the IF -- your 401(k) allows you to access the money in your account before you reach age 59 1/2, it would probably be in the form of a loan which you would be required to pay back. The interest rate on this loan will definitely be higher than what you'd pay on a student loan. And if you leave your job, the entire loan must be repaid in full to avoid a penalty.

Some 401(k)s allow you to take a withdrawal for "hardship" reasons, and tuition can qualify. But, if you are under age 59 1/2, you will owe tax and a 10% penalty on the withdrawal. To find out what is allowed under your

plan, you need to get a copy of the "Summary Plan Description." Your human resources department can supply one if you can't find the one you received when you joined.

On the other hand, regardless of your age, you can take an unlimited amount of money out of your IRA to cover college costs. Since this is one of the "exceptions" to the 10% penalty for IRA withdrawals, all you would owe is income tax on the amount you withdraw.

You are limited to taking $10,000 out of your IRA to pay for the purchase of a first-time home. And once you use this privilege, you can never take advantage of it again. Since this is your "first" home, you would qualify for an exception to the 10% penalty and would only owe income tax on your withdrawal amount.

But I want you to promise you will think long and hard before you take any withdrawals from your retirement accounts. Let's face it, in light of what the stock market has done in the past two and a half years, your 401(k) and IRA are probably not worth what they used to be. If you withdraw what's left in them today, you eliminate the opportunity for your investments to recover when the market comes back. And if you want to end up with $25,000 AFTER TAXES, you'll have to actually take out around $35,000, assuming your combined state and federal tax rate is 30%.

What's even worse, if you take the withdrawals, you permanently lose any tax-advantaged growth this money would otherwise enjoy. You don't give your age, so let's assume you're 35 years old. In that case, you have at least 30 years before retirement. If the $35,000 you want to withdraw were instead left in your account and it earned just 8%, compounded annually, it would grow to more than THREE HUNDRED FIFTY THOUSAND DOLLARS by then! (If you're younger than 35, it would be worth more.)

Siphoning money out of your retirement accounts is something which should only be done as a last resort. You'd be better off if you took out a low-interest student loan and stopped making contributions to your 401(k) until the loan was repaid.

Take care,


Dear Gail,

After 23 years with the same company, I was laid off four years ago at age 49. When this happened I rolled the $120k in my 401(k) into an IRA. I still don't have a job. The trouble is, between the withdrawals I've had to make from IRA to meet expenses and the drop in value due to the stock market decline, I only have about $8K remaining.

What will the IRS do to me if I can't pay them over $30K in penalties and taxes? Will they take the remaining $8,000? Will they put me in jail? I can't pay if I don't have a job.



Dear Jerry,

My heart goes out to you. Thousands of individuals who had to tap their IRAs because they found themselves unexpectedly out of work have seen their retirement nest eggs further reduced by the sharp decline in the stock market.

Since you are under age 59 1/2, there is a possible 10% penalty IN ADDITION to the income tax owed on your IRA withdrawals. You can avoid the penalty (sorry, there's no escaping the income tax) if your reason for tapping your IRA early is among the exceptions listed under "Section 72(t)" of the Tax Code.

As I've mentioned in previous articles, these exceptions include: paying college expenses for yourself, your spouse, your child or grandchild; a once-in-a-lifetime withdrawal of $10,000 to use toward the purchase of a "first-time" home; the death of the IRA owner; becoming disabled; being unemployed for 12 weeks and needing money to pay health insurance premiums; and paying the cost of medical expenses that are higher than 7.5% of your Adjusted Gross Income.

However, in your case, it sounds as if you just needed the money. If so, IRA withdrawals prior to age 59 1/2 can be taken penalty-free provided you follow one of three IRS-approved methods of calculating how much you can take out. If you didn't do this, then I'm afraid you probably will owe the penalty.

It is not in the government's interest -- or its goal -- to throw taxpayers in jail. However, the longer you delay, the more this is going to cost you. I strongly advise you to contact the IRS and lay out your situation just as you did with me. They are much more understanding when the taxpayer takes the initiative. They will work out a repayment schedule that takes your financial situation into consideration.

Best wishes,


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The views expressed in this article are those of Ms. Buckner or the individual commentator, and do not necessarily reflect the views of Putnam Investments Inc. or any of its affiliates. You should consult your own financial adviser for advice regarding your particular financial circumstances. This article is for information only and is not an offer of the sale of any mutual fund or other investment.