Reuters Money

Renée Hirshfield didn’t expect to tap her retirement account to pay for her daughter’s college tuition. But when she opened the bill for Sarah’s junior year at Mount Holyoke College, sticker shock set in.

“She had been getting a fair amount of financial aid, but there had been a slight spike in my income the year before,” says Hirshfield, a small business owner in St. Louis. “That pushed the formula for my expected share of the bill to about double what it had been before. I was blindsided.”

Hirshfield, who is divorced, gets some assistance on tuition from her ex-husband. Her father also had been helping out, but at age 93, he moved recently to an assisted living facility that costs $5,000 each month. “Now I need to come up with ways to shore up his finances, and cover the college bills,” she says. “I’m the sandwich generation.”

The financial stress pushed Hirshfield (pictured left with her daughter Sarah) to liquidate a variety of investments and savings to cover Sarah’s junior year, including a $3,000 Individual Retirement Account. That put Hirshfield among a growing subset of families tapping retirement accounts to fund soaring tuition bills in the midst of the toughest economic climate since the Great Depression.

The number of families raiding retirement accounts for college this year has doubled, according to a new study by Gallup and student lending giant Sallie Mae. The study of more than 1,600 families with college-age children found that 7 percent withdrew or borrowed funds from a 401(k) or IRA for the 2009-2010 academic year, up from 3 percent in the previous year.

And the amounts withdrawn or borrowed increased to $8,554, up from $5,318 in the previous year. “That kind of change in a single year is very significant, and very worrisome,” said Sarah Ducich, senior vice president, public policy at Sallie Mae.

The Sallie Mae study found that families continue to place a very high value on higher education, with 83 percent agreeing that it’s a key investment in the future of their children. Parents are cutting spending and working harder to pay for college, and the expenses are putting greater stress on all sources of saved and borrowed funds.

The reliance on retirement accounts mirrors a broader trend of cracked retirement nest eggs due to economic stress. Fidelity Investments reported recently that customers borrowing or withdrawing from a 401(k) account rose to 11 percent of active plan participants, up from 9 percent a year ago. The portion of participants with loans outstanding also increased two full percentage points in the second quarter to 22 percent. The rate of borrowing and withdrawals stood at a ten-year high, Fidelity said.

Retirement accounts can be tapped for educational purposes without incurring a penalty under federal rules, notes Fred Amrein, a financial planner based in Wynnewood, Pennsylvania. Likewise, a Roth IRA can be tapped without penalty so long as the funds have been invested a minimum of five years. However, funds drawn from tax-deferred accounts do count generate tax liability as ordinary income — which can impact eligibility for need-based financial aid in the following year.

And raiding these accounts for any reason hobbles long-term retirement planning. Borrowing or withdrawing funds will inflict serious damage because of the time those funds won’t be earning investment returns. Also lost is the opportunity to earn returns on new investments; in most cases, you can’t make contributions while you have a loan outstanding, and you can’t contribute for six months after you make a hardship withdrawal.

Families are struggling with a combination of a seemingly inexorable rise in college costs and diminished economic means. The College Board reported that tuition rose an average 6.5 percent for this year, while room and board jumped 5.4 percent. But the families surveyed by Sallie Mae perceived much higher increases, saying that their expenses rose 17 percent this year, and 28 percent compared with two years ago.

And in its annual study of college affordability, Fidelity found that families are on track to meet just 16 percent of future expenses, down from 18 percent last year and 24 percent in 2007.

“The depreciation of investment portfolios and housing values, along with high unemployment all are inhibiting families’ ability to pay for college” says Joe Ciccariello, vice president of college planning at Fidelity.

Amrein urges families to develop multi-year college plans that take into account varying income and expected aid. For example, one of the biggest variables in eligibility for need-based financial aid under federal formulas is the number of children in school in a single year.

“We do a timeline, especially where for families with multiple children with overlapping years of expenses and eligibility for financial aid,” Amrein says.

Amrein argues that retirement accounts can be an acceptable source of college funding for parents who have five or ten years to rebuild before the funds will be needed.

Hirshfield, who is 60, says she doesn’t intend to retire anytime soon.

Photo:  Renée Hirshfeld