If you received your financial aid award, and the offer doesn’t cover your expenses, withdrawing from your 401k may seem like a favorable option compared to a private student loan. While it is possible to withdraw from your 401k to pay college tuition, you may face penalties, taxes, and a reduced financial award as a result. Here’s how:
Before considering if you can withdraw from your 401k, review your employer’s 401k policy. Some companies require you to show proof of hardship before obtaining access to your 401k. In addition to providing bank statements and other evidence of hardship, you will also be required to demonstrate how you have exhausted all other options.
Early Withdrawal Penalty
Unless you are 59½, withdrawing money from your 401k automatically results in an early withdrawal penalty. In addition to the money you are withdrawing from tuition, you may lose thousands of dollars in penalty fees. Taking all fees into account, will you be able to afford retirement with an early withdrawal?
If you make an early withdrawal from your 401k, it’s viewed as income, even if the funds will be used for school. The money will be reported as taxable income to the IRS and can increase the amount of taxes due. With the increase in income, you may also face other challenges to your financial situation.
Increased Income, Reduced Financial Aid
If your 401k withdrawal is marked as income, your financial aid award could change in subsequent years. You may no longer qualify for grants, work-study, or even certain loan programs. Even if every penny of your withdrawal will be used for school, the increase in income may still reduce your financial aid award in subsequent years.
Inability to Make New Contributions
Some 401k policies outline restrictions after making a withdrawal. You may have to wait as long as six months before adding funds to your 401k after an early disbursement.
Taking a Loan From Your 401K
Because of the penalties of withdrawing from a 401k, you may consider borrowing from your 401k. The benefit of taking a loan from your 401k is that you are not subject to early tax penalties, hefty taxes, and other restrictions. However, 401k loans have their own unique set of restrictions.
Borrowers have five years to pay back a 401k loan, no exceptions. In addition, if you leave your employer before the loan is paid off, the full balance of the loan is due immediately. In the event you cannot pay back the loan, the loan can be converted to withdrawal, at which time early withdrawal penalties, taxes, and other fees are due.
Alternatives to Using Your 401k
Whether you just received your financial aid award or are funding the third year of college, you do have alternatives to withdrawing from your 401k at every stage of the process.
Appeal Your Financial Aid Award
If you haven’t yet agreed to your financial aid award, consider writing a financial aid appeal letter. Present documentation to prove hardship and request additional aid in the form of stipends, scholarships, grants, or loans from the university. Keep in mind that some students will turn down financial aid, which will increase the amount of aid available. It’s important to file an appeal early.
Private Student Loans
If you have exhausted savings, 529 College Savings Plans, and financial aid awards, you may consider a private student loan. As a parent of a college-age student, you may be considering retirement in the next 15-20 years. On the other hand, your child will have more time left in the workforce both to pay their student loan and contribute to a 401k of their own. If withdrawing from a 401k will hinder your ability to retire, it’s better to consider alternatives.
Should I Borrow from My 401k to Pay My Tuition?
Borrowing from a 401k to pay for tuition comes with many pitfalls, especially if you are subject to early withdrawal penalties. Before withdrawing from a 401k, it’s important to examine other funding alternatives. The first option should be to discuss your financial aid award with the college or university.