Borrowing from 401 K

[clarabelle]

I read somewhere that this was not a good idea -but I can't remember why.
Has anyone done this before? We are not planning on it anytime soon -but we have considered it to help pay for college for our DDs
TIA

 

[doubletrouble_vb]

It isn't a good idea and I don't remember why either. You might check www.clarkhoward.com or www.daveramsey.com for the answer... Clark will probably give you a less biased answer (you'll need to search for it) than Dave will because Dave hates the concept of borrowing.

 

[Toby'sFriend]

http://www.401khelpcenter.com/loans.html

that's a pretty good summary.


#1 Reason -- you can get financial aid and loans to pay for college. You cannot get financial aid and loans when you are 85 years old and not working. Never sacrifice your retirement planning for your kid's college.

Also remember, if your employment terminates for any reason, the loan becomes due in full or it is subject to the 10% penalty + taxes.

 

[clarabelle]

Thanks -that really helps.
The thing is -we have a HUGE 401K so taking out a little for college would not sacrifice our retirement. Thats why I was considering it. My husbands job has a match and a profit sharing that goes into the 401k -so he has always done the max.

 

[lori1043]

http://www.401khelpcenter.com/loans.html

that's a pretty good summary.


#1 Reason -- you can get financial aid and loans to pay for college. You cannot get financial aid and loans when you are 85 years old and not working. Never sacrifice your retirement planning for your kid's college.

Also remember, if your employment terminates for any reason, the loan becomes due in full or it is subject to the 10% penalty + taxes.

LOVE your siggy- I think JK Rowling has so many things in her books that relate to what happens in our daily lives-but so creative to make it into that wonderful set of novels. DD9 has read every one of them this past summer and now is re-reading 7. I don't understand why the controversy over those books-classic good and evil-LOVE wins over-LOVE it!!!

Lori

 

[KarenAylwood]

Not to hijack... but...

I have a friend who is planning to do this (again). He got a new job and is going to be making much less for a period of time (~$5/hr less). After a while he'll be making more- but not for a few months. At this former salary he could cover all expenses and had no money to save (believe me- I've had the argument 100 times with him about actually being able to save and I think he can). He wants to pay off his car (owes $16K on it) because he can no longer afford the car payment and have an emergency acct for when his wife probably has to get a new car soon.

He's mid-30's with a 401K of $140K (his wife has a Roth but with less in it). For the two of them, I don't think it's enough. He already has a $9K loan on his 401K out and wants to take out $30K now. I thought he'd be subject to the 10% penalty no matter what. Is it true that you can take a loan out but not get penalized unless you don't pay the loan back?

And I'm assuming that the money wouldn't be earning interest during the time the loan is out as well. I guess I just thought he had to pay the 10% penalty no matter what on top of not earning interest.


To the OP- don't take out on your 401K for college. It's not worth it- like what has already been said- you can get loans for college but not for retirement. When do you DD's reach college age? Maybe contribute less to the 401K and put extra into a high interest rate account for the time being. If you really want to pay for their college you could help with paying back their loans over a period of time. You're probably earning more in interest on your 401K than you would be charged in interest on student loans.

 

[MrsPete]

I read somewhere that this was not a good idea -but I can't remember why.
Has anyone done this before? We are not planning on it anytime soon -but we have considered it to help pay for college for our DDs
TIA

In addition to what other people have said, here's a story that a friend just told me recently:

She and her husband had two kids in college last year (the only year they'll ever have that situation), and they were very strapped for cash. They thought it'd be good to use 401K money instead of student loans. But here's what happened: To make the example nice and neat, let's pretend that they earned an even $100,000 in 2005 . . . let's pretend that they borrowed $20,000 from his 401K during 2006 . . . as far as the IRS is concerned, they earned $120,000 in 2006! Now it's quite obvious to us that their income stayed the same. The $20,000 was money they'd already earned in a previous year, but they'd not paid taxes on it yet -- they skyrocked up several tax brackets, and their tax bill was a whammy.

She said that if she had it to do again, she'd definitely get a low-interest student loan.

I'm no fan of student loans. I favor choosing a less expensive option, going to school part time, working several jobs, or some combination of these choices -- it seems to me that they're better options than borrowing against your future -- but borrowing from a 401K seems to be even worse.

 

[MrsPete]

Thanks -that really helps.
The thing is -we have a HUGE 401K so taking out a little for college would not sacrifice our retirement. Thats why I was considering it. My husbands job has a match and a profit sharing that goes into the 401k -so he has always done the max.

If you already have a huge 401K, why not back off on your contributions and instead direct those funds into college savings? Yes, you lose the match, but it might suit your needs better. Of course, I'm assuming that you're in my shoes and have a few years left before college begins; however, even if your child starts next fall, you could still build up something during this senior year of high school.

 

[LisaNJ25]

Not to hijack... but...

I have a friend who is planning to do this (again). He got a new job and is going to be making much less for a period of time (~$5/hr less). After a while he'll be making more- but not for a few months. At this former salary he could cover all expenses and had no money to save (believe me- I've had the argument 100 times with him about actually being able to save and I think he can). He wants to pay off his car (owes $16K on it) because he can no longer afford the car payment and have an emergency acct for when his wife probably has to get a new car soon.

He's mid-30's with a 401K of $140K (his wife has a Roth but with less in it). For the two of them, I don't think it's enough. He already has a $9K loan on his 401K out and wants to take out $30K now. I thought he'd be subject to the 10% penalty no matter what. Is it true that you can take a loan out but not get penalized unless you don't pay the loan back?

And I'm assuming that the money wouldn't be earning interest during the time the loan is out as well. I guess I just thought he had to pay the 10% penalty no matter what on top of not earning interest.


To the OP- don't take out on your 401K for college. It's not worth it- like what has already been said- you can get loans for college but not for retirement. When do you DD's reach college age? Maybe contribute less to the 401K and put extra into a high interest rate account for the time being. If you really want to pay for their college you could help with paying back their loans over a period of time. You're probably earning more in interest on your 401K than you would be charged in interest on student loans.

I have taken out a few over the years and have never had the 10% penalty. Right now I have a pension loan though hubby. I look at it as paying ourselves back and not the bank.

My aunt took out 50,000 from her 401k for home repairs. Better interest that the bank.

 

[MrsPete]

Is it true that you can take a loan out but not get penalized unless you don't pay the loan back?

No, that's not true.

It's essentially impossible to avoid paying back a 401K loan. If you remain employed, the employer deducts it from your paycheck -- you never write an actual check. And if your employment is terminated, the employer is allowed to withhold the unpaid amount from your 401K rollover. Most companies won't allow you to borrow 100% of your funds, so it's virtually impossible for you to walk away "owing" the company. If you did manage, they have your SS# and they can garnish your wages!

No, the penalties aren't in place to assure the company of repayment!

 

[becky1960]

I have never heard of a loan as being Income as for taxes, I guess it depends on the 401k plan. We have borrowed at low rates and payed it back into the 401. The total value of the 401 remained the same as long as we were paying on the loan. Most people are right in saying that it is unwise to borrow if its not being payed back right away. The penalities are pretty high if its closed out early.

 

[clarabelle]

We have 5 years. The reason we haven't cut back on the 401kcontributions -is because the match is soo good. Like free money. We aren't in any kind of dire straights-it was just something I was wondering about.
I am pretty sure we won't qualify for any kind of aid -I don't really know how all that works. Is there a website that explains how that works?

 

[LadyShiva]

Our 401k's have a 9% interest rate. I know my student loans have a lower interest rate-about 7%.

I'd look into federal loans for students before I'd take a loan on my 401k because it would be cheaper.

Brandie

 

[LadyShiva]

We have 5 years. The reason we haven't cut back on the 401kcontributions -is because the match is soo good. Like free money. We aren't in any kind of dire straights-it was just something I was wondering about.
I am pretty sure we won't qualify for any kind of aid -I don't really know how all that works. Is there a website that explains how that works?

You could also set up a 529 for your kid. I wouldn't personally cut back on my 401k; you're right, free money is wonderful!

You would qualify for loans that accrue interest immediately. Those aren't income-based.

Here's a link to study: http://studentaid.ed.gov/PORTALSWebApp/students/english/index.jsp

Brandie

 

[Floridagal23]

A loan is not income to you (via the IRS) but taking out of a 401k or other plan will a) create a big penalty for you and b) be considered taxable income to the you in the year it is received. So, you are hit with the double penalty - first the actual penalty, then the tax. The beauty of most of these plans is that they grow tax deferred - so if you have 2000/mo going in, you earn on all of that 2000 a month - which ends up being bigger than if you had 1800 after tax put in each month. I would not touch the retirement accounts if you can help it. It is not worth the penalty and you lose the large amounts that have grown tax deferred IMO.

 

[clarabelle]

Thanks everyone! Brandie -I bookmarked that website- thanks!
We do have some money saved for college -but not enough and I was wondering about my options. So much of it depends on where they go.
Do people usually apply to where they want -and then figure out the money after they are accepted? Or apply based partly on where they can afford?

 

[imsayin]

I have never heard of a loan as being Income as for taxes, I guess it depends on the 401k plan.

Per the IRS (not based on individual 401K plan), a loan is not taxable. A withdrawal would be.

 

[LadyShiva]

Thanks everyone! Brandie -I bookmarked that website- thanks!
We do have some money saved for college -but not enough and I was wondering about my options. So much of it depends on where they go.
Do people usually apply to where they want -and then figure out the money after they are accepted? Or apply based partly on where they can afford?

Applying for financial aid is somewhat tied to the college you attend, but the earliest you can turn in your financial aid form (FAFSA), the better off you are for the year.

You should apply to several schools, and don't discount a school just due to tuition and room and board. I personally suggest a state school in addition to wherever else. Granted, have an idea of what major your kid will start in and research accordingly, but don't discount a school in the state you live in. They're usually worth at least checking out.

Good luck! DH and I paid our own way through college, and I definitely think having your kid pay for at least part of their way brings a level of maturity they don't otherwise get. Whether that is covering their own rent or what have you, make it something they will need to work to achieve.

You're welcome for the link!
Brandie

 

[dcfromva]

I read somewhere that this was not a good idea -but I can't remember why.
Has anyone done this before? We are not planning on it anytime soon -but we have considered it to help pay for college for our DDs
TIA

I don't know if this is just my employer or if it is an IRS rule, but where I work you can only borrow your contribution portion (none of the match or earnings) up to a maximum of 50,000. If your employment is terminated before the loan is repaid you have to repay the balance on the loan as a lump sum or it is considered a distribution. If this happens (your employment terminated prior to the loan being repaid), you pay income taxes on the remaining loan (it is taxed as ordinary income) and if you are under 59.5 there is an additional 10% penalty.
Generally the interest rates are pretty favorable on the loan, but if you had your money invested in a higher rate of return type investment--you'd miss out on possible higher earnings.

If you are in a position to contribute to the 401K plus fund college (and you still have some years left to save), I would recommend a 529 plan. You retain control of the funds. If used for a qualified college expense, the earnings are not taxed and your state may offer tax incentives for contribution.

 

[jenimay]

I heard it was a bad idea because you are paying it back with money that's already been taxed, to only have it taxed again when you retire.