You Could Use Your Roth IRA to Pay Off Student Loans—but Should You?

January 6, 2010

Dear Carrie,

I recently graduated from college and have both school loans and a Roth IRA. I'm considering pulling some of my Roth IRA money and paying off some of my older, higher interest school loans. I've heard that you can withdraw from a Roth IRA penalty-free as long as it's principal, and not earnings. Is this true? Can I withdraw a portion of my Roth IRA to pay off some of my student loans? I'd appreciate your help and insight.

—A Reader

Dear Reader,

Congratulations on your graduation and for contributing to a Roth IRA. Both are excellent ways to pave the way for your future. And it’s exactly this type of forward thinking that I'm going to use as we look at whether it's a good idea to draw from your Roth IRA to pay down student loans.

The short answer to your question is that yes, you can withdraw the principle from a Roth IRA penalty-free. But because you can, doesn't mean you should.

What You Can Withdraw from a Roth Penalty-Free—and When
With a Roth IRA, there's an important distinction between contributions and earnings. Roth contributions are made with after-tax money. Since you've already paid the taxes, contributions can be withdrawn anytime tax- and penalty-free.

It's the earnings on those contributions that may be subject to income tax and a 10 percent penalty if you withdraw them less than five years from opening the Roth and before age 59½.

As an example, let's say you have $10,000 in your Roth IRA—$7,500 in contributions and $2,500 in earnings. You can withdraw up to $7,500 without paying a penalty. IRS rules state that withdrawals will be taken first from contributions, so in this case, if you withdraw no more than $7,500, there's no problem. You could take that money and use it to pay down your student loans.

Why It May Not Be a Good Idea
While this may seem like a good short-term solution, I'd encourage you to think of the long-term cost before writing yourself a check. Here's why. You can only put so much into a Roth each year. Currently the maximum is $5,000 with an additional $1,000 catch-up contribution if you're 50 or older. So even if you were to get a windfall, you wouldn't be able to put any more than the maximum back into your Roth in any one year. In the meantime, you've lost the opportunity for potential future tax-free compound growth on the money you've withdrawn.

Tax-free compounding over time is one of the main benefits of saving in an IRA. Your money has the potential to grow faster—and in the case of a Roth IRA, you don't pay any taxes on the earnings when you take a qualified withdrawal. But if you take money from your Roth early, even though you might not pay a tax or penalty on a withdrawal of principal, you're still losing the very opportunity for tax-free growth that makes an IRA worthwhile.

A Better Alternative
My advice is to first take a good look at your budget and how you spend your money. Find areas where you can redirect your money toward your debt. See if you can increase your payments, focusing first on the higher interest loans. You might consider cutting back on your IRA contributions for a while and using a part of that money to pay down your loans. Once you've reduced your high-rate debt, you can ramp up your retirement savings.

From my perspective, saving for retirement should be a top priority for everyone. It's great that you've started at a young age. If you continue to save just 10-15 percent of your yearly salary for the rest of your working years, you should be in good financial shape at retirement. But the key is to keep saving—not diminishing what you've already worked hard to set aside. While it might be tempting to see your Roth IRA as an easy source of immediate funds, I urge you to preserve it for the future as it's intended. I think you'll be glad you did. Good luck!

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The type of securities and investment strategies mentioned may not be suitable for everyone. Each investor needs to review a security transaction and investment strategy for his or her own particular situation. Data contained here is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.


The information on this website is for educational purposes only. It is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, consult with a qualified tax advisor, CPA, financial planner or investment manager.


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