Retirement savings account is no college fund
To help pay for your children’s college expenses, consider opening a 529 savings plan when they are young.
Whether you have a child who is applying to college now or years down the road, it might be tempting to consider dipping into your retirement savings. But when you borrow money from a 401(k) retirement plan to pay for college expenses, you're putting your own financial future at risk. You've worked a long time to build up your account, and borrowing money for a short-term need can hurt you in the long run.
Pitfalls of a retirement account loan
Here are some things to consider:
- There is a limit on how much you can borrow. Generally speaking, you can borrow only half of your account balance, up to $50,000.
- Some retirement plans will suspend your ability to make contributions when you take a loan. Even if you have a plan that doesn't, will you be able to afford making loan repayments and plan contributions at the same time?
- If you don't repay your loan according to your plan's rules, your "loan" may suddenly be classified as a "withdrawal." When that happens, you may be hit with a 10 percent early withdrawal penalty and you may have to pay regular income tax on your outstanding loan balance.
- If you lose your job, most plans require you to pay your loan back, in full, in a very short period of time (such as 60 days). If you can't, your loan will be considered a withdrawal and the penalties and taxes noted above may apply.
What about a Roth 401(k)?
- If you absolutely must tap into retirement money to fund your children's college education as a last resort, consider withdrawing money you may have contributed to a Roth 401(k). If you only borrow your contributions (and not your account's investment earnings), you may not have to pay any taxes on the withdrawals because you paid tax when you made the contributions.
Alternatives to consider
- A 529 savings plan: If you have a number of years before your children start college, you may want to open a 529 savings plan. It lets you set aside money for college without paying taxes on your savings account's investment earnings. And, if the money in your account is used to pay for qualifying educational expenses, you generally won't pay taxes on it.
- Student loans and grants: Grants in particular are often overlooked as an option to fund college expenses. Check with a school guidance counselor or search online for local grant opportunities.
- Other options: Technical schools that teach skilled trades and community colleges boasting reduced tuition rates can be good alternatives to four-year universities. Also, explore government-sponsored programs that trade service for tuition reimbursement.
One helpful website is www.finaid.org, where you can learn about types of loans, grants and scholarships and use calculators for college savings estimates.
Remember: If you borrow from your retirement plan account, you may also put your children's financial future at risk as they may have to be the ones to support you financially in your golden years.