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Should I Use My 401(k) Money To Pay My Child’s College Tuition?

Q: To finish college, our son will need an additional $20,000 for his final two years. We are thinking of using some of our 401(k) money. My husband will be almost 60 by then, so no penalty.

With our social security plus my husband’s pension, our income will be close to his present working income. We have no debt. What do you think about using 401K money in this situation?

A: Typically, I tell parents of college students not to sacrifice their own retirement in order to foot their children’s college tuition bills. In your case, however, I think it actually might be a smart strategy overall financially for your entire family.

Here are the reasons why. You meet three criteria that I think gives your family a bit more financial stability than most.

First of all, you said your son has two final years left. I’m assuming that he has already been through at least two years of college. Maybe he has already been through three years of college.

The fact of the matter is; most college students at public colleges nowadays actually need five years to graduate instead of four. But if you already know he only has two years left, and $20,000 is his financial need, that tells me he requires roughly $10,000 a year, which isn’t an excessive amount when you think about the rate of tuition inflation and the cost of a college education overall.

Secondly, you indicated that even if you use some of your 401(k) money, because you have other assets like the Social Security and your husband’s pension, you expect your income is pretty much going to be on par with his current working income. That tells me that you are in a much stronger position than most.

Unfortunately, after the retirement phase, many people find that their income drops significantly and those who are relying on Social Security experience a dramatic decrease in the quality of their life from a financial standpoint.

Social Security, only pays retirees an average of about $1000 a month. If you are able to also boost your financial standing with your husband’s pension, that is a great thing. We all know, of course, that pensions are hard to come by these days, because not many companies have kept those kinds of retirement plans in force for their workers.

Lastly, you said that you have no debt. I don’t know if you mean no credit card debt, no auto loans or just no debt completely, — as in your mortgage is already paid off too. But if that is the case, again, you have a greater degree of financial stability than do most Americans.

Being debt‑free really does keep you with so many more financial options. So if you can prevent your son from going into debt from taking out student loans, which is probably the option that he might consider if he doesn’t get the $20,000 from you, then I say yes.

Overall, for the family, you will be showing your son a great example to say, “Let’s try to do this the smart way. Let’s pay for school with cash. Let’s use our savings as opposed to taking on a loan.”

Having said all that, you might want to think about one other option, which is to let your son get serious about applying for scholarships and grants. Even if he is about to enter his junior or senior year, every single year that he is in school he can and should be applying for scholarships and grants.

This is free money that doesn’t have to be repaid, but it does require sweat equity, work, applications, essays, transcripts, et cetera, on his part. But the payoff is definitely worthwhile. If he can muster up $5000, $10,000 or even $20,000 in scholarships and grants, obviously that will prevent him from having to take on student loans. But it will also keep you from having to raid your 401K.

Good luck to your entire family … and your son is lucky to have such thoughtful, financially conscientious parents!

Should I Use My 401K to Pay for My College Tuition – Pros and Cons

Author: The Money Coach

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.

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Archive for the ‘Saving For College’ Category

Should I Use My 401(k) Money To Pay My Child’s College Tuition?

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