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Borrow from a 401(k) for College?

Kimberly Lankford

There are better ways to pay for your children's higher education than to raid your retirement account.

I am a 43-year-old single mother with three kids. I save aggressively for retirement because I don't know if I'll ever meet and marry a millionaire. If my kids do not get full rides to college, and I need to help fund their college in the next two to eight years, is it wise to borrow money from my 401(k) for the costs?

You may be allowed to borrow from your 401(k) for college costs, but there are plenty of reasons to avoid it.

If you leave -- or lose -- your job, you generally have to pay the loan back immediately. If you don't, the loan will be considered a withdrawal. You'll have to pay taxes on the money and may face a 10% early-withdrawal penalty if you leave your job before age 55.

Just the tax bill alone can be a big hit: If you can't pay back a $10,000 loan after leaving your job, you'll have a $2,500 tax bill if you're in the 25% bracket. The bill grows to $3,500 with an early-withdrawal penalty -- even if the money is long gone. "If you didn't have the money to pay back the loan, chances are that you don't have the money to pay that tax bill, either," says Stuart Ritter, a certified financial planner with T. Rowe Price.


The money also won't appreciate in your account while you've borrowed it, so you'll give up years of compounding that can make a big difference in your retirement savings.

If you have $150,000 in your 401(k) then borrow $20,000 at age 40 and pay the loan back over three years, you'll end up with more than $166,000 less in your account at age 65 than you would if you didn't borrow the money, assuming your investments earn 8% per year and you make after-tax loan payments of $618 per month rather than pre-tax contributions of $823 during those three years, according to Ritter.

You have many other options to help pay for college costs. As a single mom with three kids, you may qualify for a good deal of financial aid. See our Everything You Need to Know About College Aid for advice that can help you master the financial aid process. And even if you or your children need to take out some student loans, they'll have more time to pay them back and may qualify to deduct student-loan interest on their tax returns. Your children could even get their loans forgiven if they take certain jobs. For more information, see The Best Deals on Student Loans.

Got a question? Ask Kim at askkim@kiplinger.com.


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