Dear Dr. Don,
I stupidly began pursuing a college degree when the economy tanked. I learned that a college degree was needed just to be considered for a new job in software testing, a field I'd been in for the previous eight years. I'm now 48 years old.
Prior to working with software, I was an administrative assistant for more than 15 years. When I was unsuccessful landing another software job, I fell back on my administrative skills. Unfortunately, I'm now earning less than half of what I used to make. As a result, I'm in debt to the federal government with a $35,000 consolidated loan at almost 7 percent interest.
With $80,000 in a Roth individual retirement account, I'm considering a withdrawal to pay part of my student loan. Is it better to follow that plan and pay off the $35,000? Or should I continue making monthly payments with the fear that I'll owe the government almost twice what I borrowed? I can afford only about $200 in monthly payments.
-- Sheila Strategy
I generally recommend against people in their late 40s taking money out of their retirement accounts. But I think it makes sense in your situation, especially with a Roth IRA.
Contributions to a Roth IRA are with after-tax dollars. So, there's not the big income tax penalty that's associated with distributions from a traditional IRA.
There are so-called "account seasoning" considerations for withdrawals from Roth IRAs. They must occur at least five years after the beginning of the year when you first set up and contributed to the account.
There is also an ordering rule for distributions. It is assumed that regular contributions will be withdrawn or distributed first. Then come conversion and rollover contributions followed by earnings on contributions. If you are just taking out money you contributed, that's not subject to the 10 percent penalty tax. It's the portion of a distribution related to earnings that could be subject to income taxes and the 10 percent penalty. If you contributed at least $35,000 of the $80,000 in your Roth IRA, taxes aren't an issue there.
You should also know that President Barack Obama's expansion of the pay-as-you-earn plan for student loans is set to start in December 2015. The plan would limit student loan payments to a percentage of income and result in forgiveness of any remaining balance after 10 years of qualifying public service employment or 20 years for other kinds of employment. Comparing numbers on pay-as-you-earn versus raiding your Roth IRA can't be done at this time because we don't know all the rules yet. You could opt to keep making the loan payments until we know what the payments will be. Another issue is whether any part of the loan balance will be forgiven after 20 years.