Can You Withdraw 401(k) Money for College?
If you have to pay for your own college tuition or a child's tuition, the financial expense can be quite large. One of the ways that people often try to pay for college tuition is to borrow money from a 401k. You can take money from your 401k for this expense in a few different ways, but it could set your retirement back.
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401k Loans
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The easiest way to get access to your 401k money for college tuition is to take out a 401k loan. This type of loan is offered by many 401k providers, but not all of them have this provision available. If it is available, you can borrow as much as 50 percent of your account balance. You can use the money to pay for college and then you will have to repay the money with interest.
Hardship Withdrawal
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If your plan does not allow loans or you have already taken out as much money as you can through a loan, you could also pursue a hardship withdrawal. A hardship withdrawal occurs when an account holder takes money from a 401k as a result of a large financial hardship. Paying for college tuition is considered to be a financial hardship. When you use this method, you will have to pay a 10 percent early distribution penalty as well as taxes on the money.
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IRA Rollover
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Another option that you could look at is transferring your money into an IRA. IRAs have a provision which allow you to use money for college without having to pay any penalties. When you take money out of an IRA for college expenses, you have to pay taxes on the money, but you can avoid the 10 percent penalty. You should be able to roll money from your 401k into an IRA relatively quickly.
Warning
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Even though you can take money out of your retirement accounts for college, that does not necessarily mean that it will be in your best interest. This is especially true if you have to take out a loan to gain access to the money. When you go to repay the loan, you repay it with after-tax dollars. This makes it even more difficult to repay the money than when you first accumulated it.
Tax Brackets
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When you take a hardship withdrawal or take money out of an IRA, you have to consider the impact on your tax bracket. The money that you take out will increase your taxable income for the year. If you are on the border of another tax bracket, this could make the marginal tax rate that you pay higher on all of your income. This can make your tax liability much higher than it normally would be.
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References
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