This week, many student nationwide are rejoicing in their college decisions, having just sent their deposits to their chosen colleges. Simultaneously, parents everywhere are worrying about how to pay the upcoming tuition bill. If you’re one of these parents, you may be weighing the pros and cons of tapping your 401k for those funds. In this instance, it may be more beneficial to be a little selfish. Here’s what I mean…
Tapping your 401k to pay for college tuition is usually not a good idea. Whether you’re thinking about withdrawing funds, or borrowing against your 401k or IRA, both options end up leaving you with less funds for retirement. Anytime you withdraw funds from your account, the money will be slapped with a hefty 10 percent penalty AND subject to taxes. If you’re looking for a deal, this really isn’t your best option.
Borrowing against your account may be a wiser choice (if you have to). This is preferable because rather than getting hit with fees and taxes, you’re essentially borrowing from yourself at a low interest rate (usually about PRIME or LIBOR plus a couple points). Compared to student loan interest rates, this is not a bad deal. The downside of this option is that during the term of the loan, you’re not making interest on this money like you would have been otherwise. In fact, you’re paying interest. While using your retirement funds may at first seem like a good idea, you’re losing money in the long run.
Most financial advisers will suggest keeping your retirement funds for retirement, though sometimes they can be used if you’re in a pinch. If you’re seriously considering if this is the right move for you, keep in mind the the pros and cons of tapping your retirement fund:
- Convenient/quick way to get the funds you need
- If you borrow (not withdraw) you pay interest to your own account, not to a bank
- Borrowed funds are not taxed
- Comparable rates to other loan types
- Fees and penalties for withdrawal
- Withdrawals may count as income and actually decrease a student’s eligibility for federal aid
- If you borrow from your 401k, any outstanding funds may need to be repaid to the account within 60 days of terminating employment at a company
- You’re depleting your nest egg
- Interest on student loans is tax deductible up to $2,500 unlike 401k loans
If you are looking for other ways to help defray the cost of education for your child, there are still options besides retirement funds.
- Parent PLUS loans are federally funded loans that parents may take out on behalf of their student. In this case, the loan would be entirely in the name of the parent, but only requires a modest credit check.
- In addition, Wells Fargo offers a private loan for parents, similar to the PLUS loan. Parents would have the choice of fixed or variable rates and can borrow up to $25,000 per school year.
- You can also co-sign a private loan for your student. About 80% of loans that get approved do have a co-signer, and this will be a better deal for your child. Applying for a private loan with a co-signer increases approval chances, and could even lower the interest rate on the loan.
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