Thinking of Using Your 401(k) to Pay Your Student Loans? What You Need to Know
Student loan debt can push back your timetable for moving forward—like getting an apartment and finally living on your own. It could make you settle for a job you don’t like, or that isn’t in your field, just because you have that loan to pay back.
It’s understandable that you may be so anxious about saying goodbye to your debt that you’ll consider doing so by any means necessary. That desperation, though, could lead you down the wrong path. You might even talk yourself into taking money out of your 401(k) to pay off your loans.
But is it a good idea? Usually no.
Listen, here at Comet we usually like to present both sides of a situation and let you decide for yourself.
But when it comes to cashing out your 401(k) to pay off your student loans, we have three words for you: forget about it.
Come up with a Plan B. Your 401(k) should be considered sacred and not up for grabs before retirement, unless it's a matter of life and death.
That might be a bit of an overstatement, but you get the point. Hands off.
What's the big deal?
When you withdraw or borrow from your 401(k), you sacrifice earning compound interest on your savings.
It’s hard to make up that lost time later. Remember, compound interest allows you to earn interest on interest. When your money is out of your retirement account, you lose the luxury of that benefit—meaning that your retirement may be at risk.
Let’s take a closer look at what happens when you dip in to your retirement savings early.
Borrowing isn’t so simple
If your 401(k) plan allows it, you may be able to borrow funds from your retirement plan, but you will be obligated to pay those funds back within five years. The IRS specifies that you may borrow only 50% of the vested balance in your account or $50,000, whichever is less.
While the amount you borrow will not be considered income, the funds you borrowed will be subject to taxes and fees if you don’t repay them on time. You’ll have make payments at least quarterly.
There are penalties
If you withdraw from your 401(k) before age 59½, that distribution is counted as income.
You will have to pay income tax on that amount plus a 10% penalty for withdrawing that money early.
Hardship distributions have steep terms
Your 401(k) plan may permit a hardship distribution.
Each 401(k) plan describes the type of hardship that funds may be used for and what may be considered an immediate and heavy financial need. A hardship distribution generally cannot exceed the amount of the need.
If you take a hardship distribution, understand that neither you or your employer can add contributions to your account for at least six months after you do.
Hardship distributions are subject to a 10% penalty for early withdrawal and are considered income, so the amount may be subject to taxes. And YES, those distributions are usually subject to 10% penalty if you’re under age 59 ½.
Explore other options
The good news is that there are ways to pay off your student loan debt faster without crippling your future in the process.
Think beyond your 401(k). Look into refinancing your student loans to get a lower rate, or come up with a plan for making extra payments and paying more than the minimum each month to get out of debt sooner.
To find out how much you could save from refinancing, check out this Student Loan Refinancing Calculator.