You may have considered tapping in to your retirement fund if you were short on cash and needed access to funds after an emergency, or if you are going back to school and need funds to pay for your college tuition. It’s usually not a good idea to withdraw money from a 401k because the borrower will incur high fees for withdrawing early and could end up paying taxes on the amount they have borrowed.
Here’s a look at the pros and cons of using a 401K to pay for college tuition:
Pros of Cashing Out a 401K for College Tuition
You have two options when you are considering using 401k funds to pay for college tuition. You can either borrow against your IRA where you are essentially taking out a loan from yourself. In this scenario, you will need to pay the loan back with interest. The interest you end up paying on this loan is usually the prime rate plus one or two percentage points, and you can set up a repayment plan that suits your needs.
The other option is to withdraw money from the account directly. If you do this, your withdrawal will be subject to taxes and a 10 percent penalty.
In summary, some of the benefits of cashing out a 401K to pay for college tuition include:
- Immediate access to cash to cover college tuition and related expenses
- Can be used for tuition, books, fees and other expenses
- Same as cash
Cons of Cashing Out a 401K for College Tuition
While using a 401k for college tuition seems like an attractive option, it should only be used as a last resort. Remember that you will be using up your retirement savings to coordinate the withdrawal – an account that you’ve likely invested in for several years – and your withdrawal will be subject to taxes. If you decide to get a loan against an IRA that has been rolled over from a 401k, there is no early withdrawal penalty.
The only way to withdraw cash from your 401k is by proving that you have an immediate financial need and that you can’t source the funds elsewhere. If the conditions are met, you may use the funds to pay for higher education tuition, room and board fees for the next twelve months.
In summary, some of the drawbacks of cashing out a 401K to pay for college tuition include:
- You’re depleting your retirement funds
- Your withdrawals will be subject to taxes
- You will pay a 10 percent early withdrawal penalty
- Withdrawals may count as income and affect the student’s eligibility for financial aid
Parents who are paying all or some of their child’s college tuition may consider borrowing money from their 401k to pay for tuition, fees, and other college-related expenses, but need to be aware of the costs and penalties of doing so.