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Author Topic: Early Withdrawal of Simple IRA Funds - Always a Bad Idea?  (Read 18811 times)

tubgirl

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Early Withdrawal of Simple IRA Funds - Always a Bad Idea?
« on: April 26, 2005, 01:58:21 PM »
I'm not interested, generally, in finance (or even math for that matter), so can anyone who is so inclined comment on this?  Would the (conservatively estimated) earnings I would make on the six grand I have sitting in my IRA after working my arse off for two years to save it (I guess my EFC of 7K was pretty right on) be put to better use lessening the total amount of loans taken out? 

I can withdraw it without penalty, and even without tax for educational purposes (only the earnings are taxed, and they are a teeny amount of my total - I guess I'd leave them in there, but anyway...).  Does the earning potential outweigh, mathematically, the interest I will be racking up that amount?  I'm looking at a total of either $65K or $20K in loans, depending on where I decide to go (and I'm having SERIOUS problems deciding where to go, but that's a different story...).

So intead of the above novella, let me put it this way: Is this the one case where withdrawing money from your IRA early makes sense, or should I go with the conventional wisdom that it's ALWAYS a bad idea for your future to do so?  I mean, if it is, then why does Uncle Sam let me do it without penalty?  Just to be mean and laugh at me?

St. Shaun

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Re: Early Withdrawal of Simple IRA Funds - Always a Bad Idea?
« Reply #1 on: April 28, 2005, 05:49:12 PM »
I would leave the money in.

First of all I was told by the financial office at Michigan that I would
be penalized for withdrawing for education. 

Secondly, it depends where you have your IRA money is.  If you have it in
a standard market index mutual fund statistically you'll do better with the
money in (the average return for the S&P is around 9%, given that hasn't been
the case since 2000 when I started putting money in it).  This is amplified
by the fact that you won't have capital gain taxes.  If it's in a low yield
bond, or worse yet, a money market account your rate of return may be less then
then the interest for your student loans. (although bond accounts generally have
been doing well because of the low interest rates).

Personally I'm going to borrow additional money (aka "living expenses") and put
that into my IRA while in school.  If I go Big law I won't be able to make IRA
contributions to much longer so I want to maximize them while I can.  Of course
I also believe the market will turn around soon (or rather I thought it had).
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Boston24

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Re: Early Withdrawal of Simple IRA Funds - Always a Bad Idea?
« Reply #2 on: April 29, 2005, 09:40:23 AM »
I would leave the money in.

First of all I was told by the financial office at Michigan that I would
be penalized for withdrawing for education. 


Why would they tell you this?  I spoke with Fidelity (where my IRA is) and they said there would be no penalty.  Why did Michigan say there would be?  I had been planning on withdrawing from mine.
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limonjello

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Re: Early Withdrawal of Simple IRA Funds - Always a Bad Idea?
« Reply #3 on: April 29, 2005, 11:23:06 AM »

First of all I was told by the financial office at Michigan that I would
be penalized for withdrawing for education. 

I don't know your particular situation, but that information is incorrect for most people. You can withdraw original contributions without penalty to cover "qualified educational expenses."  Basically, up to your COA number (though I think the room and board number might be a bit more flexible than the estimated school budget), minus scholarship and grants.  So if you have loans + grants that cover your COA, you can't take out the loans and then also take out IRA contributions to make life easier, unfortunately.

EDIT:  Here is a more definitive link from the IRS itself.  Looks like I was wrong on a better COA, though.
http://www.irs.gov/publications/p970/ch09.html

Again, I don't know your situation, but most folks will need all the money for actual living expenses, and they won't be able to borrow additional money above the COA except with a private loan, and it's unlikely the rate you get on that will make the IRA investment a good deal (plus, as opposed to borrowing on margin on a liquid stock asset, your IRA is not as liquid without penalty, so you are tying up your set debt against a non-liquid and non guaranteed return financial vehicle.  That's a bit risky, though it could pan out).

Boston24

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Re: Early Withdrawal of Simple IRA Funds - Always a Bad Idea?
« Reply #4 on: April 29, 2005, 11:26:28 AM »

First of all I was told by the financial office at Michigan that I would
be penalized for withdrawing for education. 

I don't know your particular situation, but that information is incorrect for most people. You can withdraw original contributions without penalty to cover "qualified educational expenses."  Basically, up to your COA number (though I think the room and board number might be a bit more flexible than the estimated school budget), minus scholarship and grants.  So if you have loans + grants that cover your COA, you can't take out the loans and then also take out IRA contributions to make life easier, unfortunately.

Again, I don't know your situation, but most folks will need all the money for actual living expenses, and they won't be able to borrow additional money above the COA except with a private loan, and it's unlikely the rate you get on that will make the IRA investment a good deal (plus, as opposed to borrowing on margin on a liquid stock asset, your IRA is not as liquid without penalty, so you are tying up your set debt against a non-liquid and non guaranteed return financial vehicle.  That's a bit risky, though it could pan out).

So you're saying it could make sense to withdraw, right?
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limonjello

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Re: Early Withdrawal of Simple IRA Funds - Always a Bad Idea?
« Reply #5 on: April 29, 2005, 11:40:07 AM »

First of all I was told by the financial office at Michigan that I would
be penalized for withdrawing for education. 

I don't know your particular situation, but that information is incorrect for most people. You can withdraw original contributions without penalty to cover "qualified educational expenses."  Basically, up to your COA number (though I think the room and board number might be a bit more flexible than the estimated school budget), minus scholarship and grants.  So if you have loans + grants that cover your COA, you can't take out the loans and then also take out IRA contributions to make life easier, unfortunately.

Again, I don't know your situation, but most folks will need all the money for actual living expenses, and they won't be able to borrow additional money above the COA except with a private loan, and it's unlikely the rate you get on that will make the IRA investment a good deal (plus, as opposed to borrowing on margin on a liquid stock asset, your IRA is not as liquid without penalty, so you are tying up your set debt against a non-liquid and non guaranteed return financial vehicle.  That's a bit risky, though it could pan out).

So you're saying it could make sense to withdraw, right?

I'm not telling.   ;)

Basically, yes, it could make sense.  As Shaun alluded to, it depends on the opportunity cost.  More than likely, you would be better off taking at least the subsidized loan instead of making an IRA withdrawal.  More than likely, the interest rate and the advantages of subsidization make it probable that the return from your IRA is greater than your effective interest rate on the loan (and don't forget the potential to deduct some loan interest later.).  After that, it really depends on the effective interest rates on the unsubsidized loan (and being unsubsidized increases the effective rate due to interest capitalization) or any private loan. 

Really, it's best to think of it as a basic finance problem (you could extend it, but best to keep it simple, I believe).  You are comparing the expected rate of return from your investment (your IRA) vs. the effective cost of capital (your loans).  If the expected rate of return is reasonably higher than the debt cost, then you should take on the debt vs. withdrawing from your IRA.  If it is less, then I would take out from the IRA.  f it looks close, then it really depends on your comfort with taking on risk.

St. Shaun

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Re: Early Withdrawal of Simple IRA Funds - Always a Bad Idea?
« Reply #6 on: April 29, 2005, 12:19:36 PM »
Really, it's best to think of it as a basic finance problem (you could extend it, but best to keep it simple, I believe).  You are comparing the expected rate of return from your investment (your IRA) vs. the effective cost of capital (your loans).  If the expected rate of return is reasonably higher than the debt cost, then you should take on the debt vs. withdrawing from your IRA.  If it is less, then I would take out from the IRA.  f it looks close, then it really depends on your comfort with taking on risk.

It's a little more complicated than that, especially if it is likely that you will be making more than 90,000 a year (OK, it's a lot more complicated).  The problem with withdrawing money from your IRA is that you can't put it back in.  In otherwords you can only put 4,000 (for the next few years, then 5,000 then increased every year by the consumer index), and you can't put back money in you took out in previous years.  For people making over 90,000 the amount is less and is decreased to the point where people making considerably more than 90,000 can't put money in an IRA at all. 
It really makes no difference if were referring to a standard IRA, but if you money is in a ROTH IRA (like mine) then the advantage of no capital gains tax or taxes on dividends makes the compounding interest that much more potent.  If you look at retirement calculators you will see that taking $5,000 out of a ROTH IRA and then investing it in the same fund (same interest rate) outside the ROTH IRA tax shield will cost you thousands of dollars over the course of 30 years.
I should really put together a spread sheet to calculate the difference, but I don't have the time right now.  Does anyone have a spreadsheet like this?
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St. Shaun

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Re: Early Withdrawal of Simple IRA Funds - Always a Bad Idea?
« Reply #7 on: April 29, 2005, 12:26:24 PM »
To further clarify the IRA withdrawl fee, I was told by the financial aid person who spoke at the visit weekend that they only count 75% of your IRA money because of the cost of early withdrawl.  I took it to mean that you have to pay the fee to withdraw money for college.

Does anyone know if I can withdraw money from my wife's IRA to pay for my college.  She has a good amount that rolled over from her 401K, and since it isn't a ROTH IRA, and it would be a taxable event to convert it, I'm thinking it may be a good idea to use it to pay for college.  Oh wait, now I remember that I have confidence in the market, that's right, never mind.
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limonjello

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Re: Early Withdrawal of Simple IRA Funds - Always a Bad Idea?
« Reply #8 on: April 29, 2005, 12:53:39 PM »
Really, it's best to think of it as a basic finance problem (you could extend it, but best to keep it simple, I believe).  You are comparing the expected rate of return from your investment (your IRA) vs. the effective cost of capital (your loans).  If the expected rate of return is reasonably higher than the debt cost, then you should take on the debt vs. withdrawing from your IRA.  If it is less, then I would take out from the IRA.  f it looks close, then it really depends on your comfort with taking on risk.

It's a little more complicated than that, especially if it is likely that you will be making more than 90,000 a year (OK, it's a lot more complicated).  The problem with withdrawing money from your IRA is that you can't put it back in.  In otherwords you can only put 4,000 (for the next few years, then 5,000 then increased every year by the consumer index), and you can't put back money in you took out in previous years.  For people making over 90,000 the amount is less and is decreased to the point where people making considerably more than 90,000 can't put money in an IRA at all. 
It really makes no difference if were referring to a standard IRA, but if you money is in a ROTH IRA (like mine) then the advantage of no capital gains tax or taxes on dividends makes the compounding interest that much more potent.  If you look at retirement calculators you will see that taking $5,000 out of a ROTH IRA and then investing it in the same fund (same interest rate) outside the ROTH IRA tax shield will cost you thousands of dollars over the course of 30 years.
I should really put together a spread sheet to calculate the difference, but I don't have the time right now.  Does anyone have a spreadsheet like this?

That's what you're financial advisor is for.   ;)

This was in reply to a SIMPLE IRA and not a Roth.  I believe it still applies, and needn't be horribly complicated.  You are correct on Roth, except it is $95K and $150K for married filing jointly.  Some folks may have to worry about this, but many won't.  If you're making that much money and splitting hairs that finely, I think you would be in the minority (not saying it is not logical, but we're talking small differences here).  They will also most likely have other investment vehicles available to them later when working.

The 25% penalty does not apply if you use the money for COA items.  The Michigan advisor is wrong unless you inquired about borrowing above and beyond the COA minus grants/scholarship.  And yes, your spouse can take money out of her IRA to pay for your educational expenses.

Louffie09

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Re: Early Withdrawal of Simple IRA Funds - Always a Bad Idea?
« Reply #9 on: June 10, 2009, 11:01:00 PM »
I'm not interested, generally, in finance (or even math for that matter), so can anyone who is so inclined comment on this?  Would the (conservatively estimated) earnings I would make on the six grand I have sitting in my IRA after working my arse off for two years to save it (I guess my EFC of 7K was pretty right on) be put to better use lessening the total amount of loans taken out? 

I can withdraw it without penalty, and even without tax for educational purposes (only the earnings are taxed, and they are a teeny amount of my total - I guess I'd leave them in there, but anyway...).  Does the earning potential outweigh, mathematically, the interest I will be racking up that amount?  I'm looking at a total of either $65K or $20K in loans, depending on where I decide to go (and I'm having SERIOUS problems deciding where to go, but that's a different story...).

So intead of the above novella, let me put it this way: Is this the one case where withdrawing money from your IRA early makes sense, or should I go with the conventional wisdom that it's ALWAYS a bad idea for your future to do so?  I mean, if it is, then why does Uncle Sam let me do it without penalty?  Just to be mean and laugh at me?
I think, that is not his intention rather he wants to help you to earn money for your future! Don't think it negative about on what your uncle has made. Think positive!



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