There are two primary drawbacks to using your 401(k) for college funding. First, if you withdraw funds from your 401(k) before you are 59½, you may owe a 10 percent premature distribution penalty on the withdrawal. This penalty is in addition to income taxes you will owe on the withdrawal. Second, frequent dips into your 401(k) reduce the amount of money you have available to reap the benefits of compounding and tax deferral. This, in turn, reduces the overall funds for your retirement.
If you really need to use your 401(k) to pay for college, a better option might be to borrow from it if your plan allows loans. Plan loans are not taxed or penalized, as long as you repay the funds within a specified time period. But make sure you compare the cost of borrowing college funds from your plan with other finance options. Although interest rates on plan loans may be favorable, the amount you can borrow is limited, and you generally must repay the loan within five years. In addition, some plans require you to repay the loan immediately if you leave your job.
Meghan, without know more about your financial circumstances, I would suggest that it's generally a very bad idea to either borrow from or withdraw from your 401(k) plan to pay for your children's education. You should encourage your children to apply for scholarships, work part-time, and/or apply for financial aid. Even if your children need to take out student loans in their names, you should recognize that they have many more years to pay back loans at an affordable rate than you have to save for your retirement. If you find that you have the resources in retirement to help pay their loans, you can easily do so. As always, you would benefit from meeting with a competent, objective financial advisor who can review your overall financial circumstances and best advise you on your college funding strategies.
No . . . why would you do that? There are loans, grants, scholarships, and long lost rich aunts that can help kids pay for college. To my knowledge - there isn't a single loan, grant, or scholarship to pay for your retirement. I appreciate that you want to help your children, but don't put yourself at risk. When they sign the paperwork to borrow money to get an education, reality will set in that real life just began.
At the risk of sounding repetitive, I must concur with both Kimberly and David.
While it is the natural inclination of a parent to try to support their children wherever possible, especially in an effort as worthy and expensive as higher education, using retirement funds to do it is ill-advised.
Retirement plans exist to do one-thing; fund retirement. The nest-egg you are building up in your working years is largely what will carry you through your retirement. Other sources such as scholarships, loans, and work-study exist to finance higher education. I encourage you to explore these options as a means to pay for college. You can borrow money to go to school, but there are no loans in retirement.
My recommendation would be similar to David’s in that if you find you have the funds to help offset student loan payments later on, you can help in that way. Don’t forget when it comes time to pay student loans; borrowers often have the opportunity to use income-based repayment, graduated repayment and consolidation (to take the debt out over a longer period of time) to help ease the payment burden. In addition, some professions, healthcare and teachers in particular, are needed in underserved areas wherein student loan subsidies are made available to new graduates they choose to work in those areas.
Best of luck to your children as they enter college, they have a bright future ahead of them and are lucky to have the support of a parent so willing to help!
Lee's answer is the one you are going to get from everyone, I believe. Unfortunately, you have to take care of yourself first (like when the Oxygen masks come down on the airplane, affix your own first), and you simply can't finance your retirement with loans.
Planning for college tuition is a daunting task. Since your 401(k) plan is designed for your retirement years, it should probably be the last place you go to finance college tuition depending on other resources you may have. Have you established a 529 College Savings Plan? This is an education savings plan operated by a state or educational institution designed to help families set aside funds for future college costs. If you are a home owner and with values up recently, you may consider a home equity line if you have enough equity in your home. You could also look into financial aid programs for college students.
If withdrawing money from your 401(k) is your only option you will need to find out from your employer if there is a loan feature in place and the number of loans that are allowed (you can only borrow 50% or $50,000 whichever is less) or if your plan allows for hardship withdrawals and under what circumstances. If you have further questions, please don’t hesitate to contact me at 415-345-8185 or email email@example.com
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I have to agree with most of the previous comments. A 401k is designed as a retirement plan. You have funded it over the years with your, and your employers's, hard earned dollars. And, someday, you will need that money. If it's not there, you may have to depend on your kids... not a good scenario.
Not knowing your age, or other financial information, it's not possible to give you "the" definitive answer.
From the time my children were young, I made a "deal" with them... and, that "deal" was, that I would cover the cost of four years at the local state university, with them living at home. Anything above that would be covered by them, either through grants, scholarships, or student loans (my theory there is that they'd have a lot longer to pay off those loans than I would).
And, it's actually worked out fine. My daughter paid the difference for her private college education by working part time for her Bachelors Degree, and managed to get student aid and acquire loans to pay for her Masters Degree.
I've seen clients over the last 29 years in this profession spend exorbitant sums of money to finance a couple or three years of higher education, room and board away from home, (and probably more "party time") than I could imagine, only to see the kid either quit or get booted. Many of those kids work in professions today that do not require a college degree. Many of those parents are still working at age 70+.
While I'm a firm believer in higher education, it's not for everyone, and, in my opinion, the institution choice for the first four years doesn't matter as much as it once did. And, if they have to contribute, at least partially, they "own it" as much as you do.
My daughter has a lot of pride in the fact that she wasn't totally dependent upon her parents in achieving her goals. And, we're proud as well, in that she probably learned a lot more from those "life lessons" than she could have just acquiring a "sheep skin" totally financed by "Mom and Dad".
A 401(k) should be intended as a retirement plan, and except for dire emergency, I do not recommend withdrawals. The taxation and penalties are there to remind you of this.
Fortunately, there are a myriad of student funding options available; grants, scholarships, student loans, etc. Though student loans will saddle your children with debt after graduation, it is still a far better alternative than decimating your retirement plan. You will likely need it sorely at retirement one day.