What is the best way to pay off graduate school debt using my 401(k)?
I have grad school debt that I'm trying to pay off as soon as possible. I have savings in my 401(k) and I am trying to determine the best way to use these funds to help pay off my education loans. What would be the most tax efficient way of doing so? Should I roll over my 401(k) to an IRA? Is it possible to avoid paying the 10% penalty and taxes?
The best way to pay off your student loan debts is to use your earned income and leave the 401k or any other retirement account alone. It’s not worth of paying any extra 10% penalty on top of your current tax to eliminate the loan debts. I understand your fear, frustration, and urgency to pay down the loan as soon as possible as I work with many doctors who are freshly out of residency or fellowship programs, and the average loan size is about $250k. So, I give you the same advice as I give to all those doctors—not only I want you to fund your retirement accounts to the maximum but also aggressively pay down the student loan. You may say, “Lady, that’s impossible. You don’t know my situation.” I may not know your personal situation, but I do know the purpose to obtain that graduate degree is for a better future and bigger pay off for you and your family. The key is not to be carried away by the higher pay as we all tend to morph into a higher life style that our income brings us.
First thing first, develop your budget and have the determination that you can do this. Know your fixed expenses (tax, food, shelter, clothing, insurance, etc.) and work on your variable expenses (entertainment, dining out, travel, and so on). You may have no control for your fixed expense, but you are definitely in control of any variable expenses. Continue to live on the old or a beginner’s salary so than any raise can be used towards the student loan principal. Make sure you write on the cover letter that any extra is used for the principal payment, not the next or future payment. Secondly, shopping around to refinance your student loan on the private market (SoFi, Discover, CommonBond). You will be amazed to see what a good credit score can do, a much lower interest rate, which directly translates to a lower payment and extra pays towards the principal. Lastly, set at least 10% of your salary towards your 401k. If you can’t do 10% now, who do you think will bail you out during the retirement? You can fund the education with a loan, but you can’t fund a retirement with the borrowed money.
Hope those simple tips help you achieve your goals. Best!
Although you do not indicate, are you still working and thus have an employer currently offering you this 401k? If so, then you may consider taking out a loan against your 401k account balance. The IRS rules say the max you can take out is 50% of your 401k account value, or the lesser of $50,000.00. This may, or may not accomplish your debt retirement goals.
One caveat on loans, should you every leave the employer, the loan cannot be transfered to an IRA. It must be paid off. It if cannot be paid off, the closure of the 401k, and loan, will generate a 1099 income statement for the amount of the unpaid loan.
When doing a loan inside of a 401k, you are basically paying yourself back at a market rate of interest.. say 5% to 6% right now.
Should you choose to cash out your 401k, or move to an IRA and cash out then, of couse you will have income taxes from Federal, to possible State and 10% IRS penalty if under age 59 1/2.
The only way you can pay off your graduate student debt tax free from your 401k is to borrow from that account. You can borrow up to 50% of the account value not to exceed $50,000. You would then have 5 years to repay yourself the debt. There is an interest on the loan but generally it is paid to your account. The downside is that you have to pay the loan with after-tax money. Also, you have to repay it generally on a monthly basis. If you don't pay it back, you are taxed at ordinary income rates on the money you did not pay back and a 10% penalty if you are younger than 59.5. Generally, the loan rates are reasonable and possibly lower than your school debt loans. You can check with your human resources department in your company or speak with the custodian of your plan. You cannot borrow from an IRA.
If you intend to use your retirement funds to help you pay your college debt, taking out a loan is the most efficient (but not perfect) way. You would need to still be working at the employer sponsoring the plan and can't take more than 50% of your balance.
There is also some caveat.
1) If you leave your place of employment, you will need to pay the loan off or the amount will be considered as a distribution.
2) The portion attributed to the loan won't be invested. You might be missing on possible growth.
You can't take a loan from an IRA, therefore do not roll the money over if you intend to take a loan from your plan.
I hope this helps.
Never use 401(k) or any retirement funds to pay off student loans. The government was willing to loan you money for your education but no one will loan you money to retire on. Most likely you are getting a tax deduction on some of your student loan interest. Unless you are 59 1/2 years old, you will have to pay the penalty tax on your 401(k) withdrawals.