Withdraw From 401K to Pay For School

You stated that you very much want to avoid having debt when you finish your schooling. Given that, other factors need to align to outweigh your desire to avoid debt, for you to choose to take the loans

I do not have enough information to give you a specific recommendation, but I will make some observations I feel may help you.

Know your tax obligations, when withdrawing from a 401(k) account

In general, a person needs to be very careful when withdrawing money from a 401(k) plan. (In 401(k)-speak, withdrawing funds from a 401(k) is known as a "distribution.") One reason is that any distribution needs to be declared as taxable income, when filing a tax return. I have heard many people state that they asked the 401(k) plan administrator to withhold enough money to cover any tax obligation that will be due, but then ended up owing anyway. Sometimes, this happens because the distribution boosts the individual into a higher tax bracket. The last thing one wants is a problem with the IRS or state tax authorities, so make sure that you understand the exact tax implications of a withdrawal.

Will you have to pay a 10% penalty?

Before you decide to take a distribution, check with the plan administrator. Find out if you will be subject to any penalties. In most cases, taking money out of a 401(k)plan before you are age 59½ subjects you to a 10% penalty. Often, there are hardship exceptions, where no penalty applies.

Despite the IRS definition of a hardship, it is crucial to determine the specific rules of your 401K plan. Some plans consider it a hardship only if you have already exhausted every other source of funding the need, such as liquidating assets or borrowing money from a commercial source.

In your case, you need to see if you would or would not be subject to the 10% penalty, were you to take money out to fund your education. If you are told that you are not subject to penalties, ask to get that in writing from the plan administrator. This way, in case the IRS views things differently, you can point the finger back at the plan administrator.

Weigh all the pluses and minuses

If you are not subject to any penalties, withdrawing money from the 401(k) account could make sense. You would be withdrawing the funds while not earning a lot, thereby likely ending up in a lower tax bracket. Depending on how much you withdraw, you still may have some tax obligation, so here are some things to consider. How much is your schooling going to cost and for how many years? If you need to take money out of the 401(k), taking just enough to cover your costs year by year is better than taking it all out at once, as it will keep you in a lower tax bracket. Consider how much the interest rate would be on the student loan and how long a term they give you to pay it back. If you itemize on your tax return, factor in the deduction you are eligible to claim for your student loan interest, when computing the total costs of the loan.

The specific investments that make up your 401(k) plan also need to be considered. If you feel that you are liquidating those assets at a trough in the market, it may make more sense to take out the student loan than to sell at a low price.

You can examine all of these issues year to year. It may turn out that you fund some years of your education with money that you withdraw from your 401(k) account and other years by taking out a student loan.

I hope this information helps you Find. Learn & Save.

Best,

Bill

Bills.com