As the costs of college continue to rise, many graduates become burdened with student loans. Repayment of student loans is a top-priority issue for most students and graduates. Payments of student loans can have a major impact on budgets, preventing students from focusing on their academics. When the balance in your 401k is growing, you might find yourself wondering if you can use that balance to pay off your loans. In this article we shall see Can I withdraw money from my 401k to pay student loans?
You can withdraw money from your 401k to offset student loans. However, since the balance in your 401k account is intended for retirement, there are rules guiding the withdrawal of funds prior to when they should have been withdrawn. It is essential to have an understanding of these rules and guidelines before taking the step to use money from your 401k in such manner.
Rules Regarding Withdrawal From your 401k
- You will need to make a 10% penalty tax payment for withdrawing funds from your 401k if you are below 59 ½ years.
- You will also be required to pay federal income taxes on the amount that is withdrawn.
- You might also be required by some states to pay income tax on the withdrawn amount.
- You might however be exempted from the withdrawal penalty according to the IRS guideline referred to as the rule of 55. This rule states that those who are 55 years or older, and who leave their jobs for whatsoever reason, might be able to withdraw funds from their 401k without any penalties. Income taxes will however still be owed.
Borrowing funds from your 401k
If you do not want to pay the penalties that have been imposed on early withdrawal from a 401k, you might be able to instead borrow money from your 401k. However, this option is not provided by all administrators. If your administrator allows for loans, be sure to confirm the allowed amount, time frame for repayment and the interest rate as these features might vary from administrator to administrator. The general rules for borrowing as provided by the IRS are:
- You are only allowed to take loans from vested funds contained in the 401k
- There is a cap on the amount that can be borrowed. You can either borrow half of the vested funds or at most, $50,000, whichever is the greater amount
- Multiple loans can be taken as long as the maximum amount borrowed does not exceed $50,000.
- Income taxes are not paid on loans of this kind.
- These kinds of loans are required to be paid within five years, although the timeframe may vary according to the plan administrator.
- The IRS requires payments to be made in equal payments, quarterly. These payments must also contain principal and interest.
- The interest payments are returned to your 401k since the loan was made using your vested money.
Long-Term Risks Associated with Using Your 401k To Pay Off Student Loans
Asides the penalties, using your 401k to pay off student loans has some consequences. When the funds are withdrawn, you might miss out on compounding interest. Even if you eventually repay the used funds, you will still be lagging behind on your savings for retirement. You also need to take into consideration, the rate of return against the rate of interest that are being paid on the student loans. There are other ways to gradually pay off student loans and these should be considered first before opting to use funds from your 401k.
Options That Might Help with Student Loan Repayment
There are some loan debt relief options to consider if you are considering using your 401k to pay off your student loans.
- Income-driven repayment: Students who have federal loans can apply for this sort of plan which calculates the amount to be paid monthly based on your earned income and the size of your family.
- Loan deferment or forbearance: These options halt your loan payments for up to one year based on circumstances.
- Working hand-in-hand with your lender: This option is for those who have taken out private loans. Some lenders offer incentives and options that can make loan repayment easier.
- Charities and donors: There are certain nonprofit or charitable organizations that can help students pay off their loans. You should get in touch with these organizations. Some individuals can also help offset loans.
- Loan forgiveness: There are certain jobs and sectors which qualify a student for repayment assistance or loan forgiveness.
For alternatives to quickly repay your student loans, you might consider the following:
- Refinancing: This allows the student the opportunity to obtain a new loan with which they can pay off the previous loan. You might be able to lower your loan interest an also change the term of your repayment.
- Extra payments: If you receive extra money from a windfall, you might make extra payments to save on cost of interest.
- Side hustle: Starting a job on the side can allow you earn extra money. This can be a great way to pay off debt.
- Creating and sticking to a budget: If you can focus on spending money on only the important things and cutting out unnecessary expenses, you can save money which can be put into paying off your loans.
You might not have any problems paying off your student loans but want to pay them off as quickly as you can. You might want to lower your debt-to-income ratio or reduce the stress of having a debt over your head. Whatever the reason may be, there are various options to consider. Taking out of the money in your 401k is not the best option as this money has been put aside for future use. You should consult your lender to discuss other loan repayment options before resorting to using funds in your 401k.
Frequently Asked Questions
- How is money in my 401k invested? Most companies utilize a third-party provider to handle the management of 401(k) accounts. The IRS regulates these providers to ensure they manage the funds in line with rules and regulations. These providers offer options to fund holders on how their money should be invested.
- What happens to my 401(k) if I switch jobs? When you switch jobs, the most recommended mode of action should be a rollover. This is when you move the funds in your 401k account to an individual retirement account (IRA) or to a 401k account at your new job.
- What is the difference between an IRA and a 401k? 401k accounts are usually linked with your employment however and IRA is not linked to your employer. Though both accounts have contributions deducted from them before they are taxed.
- How much should I contribute toward my 401k? You should contribute between 10 – 15% of your total income towards your retirement. You might also calculate how much you may need to save by using online calculators that might estimate how much you’ll need at retirement. These calculators include CalcXL and Nerdwallet.