You work hard to put away money each month for your 401(k). And seeing the growth over the years helps you feel secure about your retirement.
That is, until the first bill for your child’s college tuition arrives.
Finding the funds to cover the cost of college can be difficult. That’s why you may be tempted to use your 401(k) as a way to help pay for your child’s college education.
But is it the best idea? Let's dig in to what you can and can't do with your retirement—and what you should consider before you make your next move.
Can you withdraw from a 401(k) for education expenses?
Yes, you can generally take an early withdrawal from your 401(k), but it's important to know that doing so will comes with some serious consequences.
First, there are some hoops you may have to jump through to access the funds. Some employers may limit access to your 401(k) while you are still employed.
That means you have to prove hardship to be considered. Even then, your employer may require you to provide proof that you have exhausted all of your other options to fund college.
Plus, if you're under 59 1/2 years of age, and still working for the employer that is sponsoring the plan, you will incur some fees. The IRS will charge you a 10% penalty tax on the amount you take out, and you will be responsible for income tax on that amount.
Can you borrow from a 401(k) for education expenses?
You may also be wondering about the possibility of taking a loan from your 401(k) to pay for college.
In many cases, it is possible to take a loan from your own retirement account. If you decide to do so, you then become the lender—but you are also responsible for making payments back to your retirement account.
Typically, you have five years to pay back the loan. Any longer than that, and you may have to pay income tax or fees on the amount you borrowed. And if you leave your job, you may be required to pay it back immediately.
You should also know this is not an unlimited pot of money. There is an upper limit of how much you can borrow from your 401(k).
Should you use a 401(k) for education expenses?
If you’re still contemplating borrowing or withdrawing from your 401(k), then ask yourself this question: “Do I need the money that is in my 401(k) for retirement?"
If the answer is “yes,” then you should not be using these funds for college expenses.
At some point, you will want to retire. If you’ve been taking money out of your 401(k) to help fund your child’s education, you may jeopardize your own retirement.
Still not convinced? Here’s another way to think about it: You or your child can borrow money for college. You cannot borrow money for your retirement.
You should also consider that your child has their entire life to pay back student loans. You have fewer years left in the working world. You need to protect your financial future.
What can you do instead of using a 401(k)?
Since taking out a withdrawal or a loan on your 401(k) is not a good idea, you might be wondering what other options you have if you've already exhausted all of your options for scholarships, grants, and federal loans.
One way to help cover the financial gap is to consider taking out a private student loan.
You have two options when it comes to private student loans:
- You can take out a loan in your name, or
- You can cosign a loan with your child (their name is primary).
If you choose to take out a private student loan rather than using your 401(k) funds, you can borrow the money you need without compromising your retirement.
Often, the terms are quite reasonable, which allows you to find room in your budget to make a payment on a private student loan.
If you decide to pass some of this responsibility onto your child, you can cosign a loan with them. Your credit is used to determine eligibility for the loan, which can result in a lower interest rate.
Plus, some lenders will release you as the cosigner once your child has made a total of 24 consecutive, on-time payments.
However, when you cosign a loan, you agree to take on all financial responsibility if your child defaults on their payments. That is something to consider, especially since it can negatively impact your credit score.
If you want to learn more about how a private student loan can help fund your child’s education, check out our guide to The Best Private Student Loans of 2018.