Most parents have savings and investments to pay their children’s college cost. Those who have not prepared enough, however, may find the need to tap their retirement accounts, such as their 401(K). If you’re contemplating on loaning from your 401 (K) to augment your college funding solutions, here are some things you should be aware of.
It significantly reduces your overall retirement funds. Borrowing from your account limits the growth of your earnings. For instance, if you take out a $25,000 loan, that amount won’t be earning any interest all throughout the loaning period. Therefore, you lose not only the gains from the accruing interest but also from compounding and tax deferral.
It involves penalties. If you dip into your 401(K) before you’re 59½, you will pay a penalty of 10% for premature withdrawal. You will also get taxed at a higher rate for that withdrawal, and these are all in addition to the income taxes you will owe once the account reaches maturity.
It impacts your child’s financial aid. The family income matters much when it comes to financial aid recalculation. All early distributions are counted as income and these impact the amount of financial aid your child may qualify for in the future years. Some experts advise postponing retirement withdrawals for later college years to avoid a significant blow to your child’s financial aid.
It gets more costly when you leave or lose your job. According to Forbes.com, your ex-employer is likely to demand a quick repayment of the loan. Failure to do so would result in the outstanding balance being treated as an early distribution, in default. Aside from getting subjected to a penalty, you would also have to pay taxes and additional fees.
Tapping your 401(K) may mean risking comfort for your later years. With a slim retirement fund, you may end up having to rely on your child. He may not need to pay much on student loans, but he would bear the burden of supporting you. It’s basically a chicken-and-egg situation. This is the main reason why your retirement savings should be safeguarded at all costs.
As a supportive parent, you may dread seeing your child buried under student debts. Even so, this doesn’t mean you should sacrifice comfort for your golden years. Thorough financial planning will be needed to get the right balance, and to that end, consultants such as John McDonough of The Studemont Group College Funding Solutions, LLC can help you find efficient ways of playing a portion of your retirement funds. Between this and other viable solutions for college funding, you can support your child’s higher education without putting your future security in detriment.
(Source: 11 Ways To Tap Retirement Cash Early, Without A 10% Penalty, Forbes.com)