Owe Yourself Tomorrow: Borrowing from Your 401(k) to Pay for College By: Diana PowellESQ.

“Let our advance worrying become advance thinking and planning.” Winston Churchill

Experts continue to warn us that we are simply not saving enough for retirement.  People on average are not taking advantage of their 401(k)’s and other savings options available to them at the workplace.  We seem to live in a “YOLO” (You only live once) when we should think in terms of “SITUP” (Save it to use, People)! 

Investopedia defines a 401(k) plan as “a qualified plan established by employers to which eligible employees may make salary deferral (salary reduction) contributions on a post-tax and/or pretax basis.” (source: Investopedia)  This is the retirement savings plan offered by most large and mid-size corporations to employees that create “automatic savings” for the future. (source: 401Kafe)  Work today, plan for tomorrow in order to be able to support yourself when it is time to stop working and retire by putting money away in a 401(k).  Unfortunately, life gets in the way when it comes to saving for retirement.  One of the biggest obstacles to saving for retirement happens to be youth – “workers under the age of 35 have the lowest 401(k) participation of any age group.” (source: Center for Retirement Research) Younger workers simply don’t think about saving for the future.  The cost of living is another huge detriment to saving for retirement—the biggest costs being higher education.

The cost of higher education has skyrocketed over the past 25 years.  According to Cronin, Data shows that “the average price of a four-year college education has risen 440 percent—more than four times the rate of inflation.” This begs the question—where is  the money coming from?  Financial aid in the form of loans is the resounding answer.  Loans typically come in one of two forms: (1) federal, low-interest Stafford loans and Pell Grants; or (2) higher interest, unregulated, private student loans.  However, the private student loans come with a lot of risks and, the tactics employed by private colleges and banks have been compared to “those employed by the subprime lending market,” and students graduating from four year colleges and universities are coming out saddled with “debt that they can’t possibly repay.” (source: Roos)  This has parents looking for alternative ways to fund their children’s college costs and some are considering borrowing from their 401(k)’s.

Loans from 401(k)’s are allowed by law.  The statutes governing plan loans usually do not place specific restrictions on the use of the loans, but do state the loans “must be reasonably available to all participants.” (source: 401khelpcenter)  However, employers place use restrictions within their Summary Plan Documents on the acceptable reason for borrowing from a participant’s 401(k), of which to paying for education expenses for yourself, a spouse or a child is typically allowed.

The only issue remaining is whether it is a good idea to borrow from you 401(k) to pay for college expenses.  There are pros and cons, but in the end it will always come down to planning.  If a person begins early enough to save for retirement, then presumably he or she will have enough saved to comfortably borrow from the 401(k) to help pay for the college expenses to offset the “cons” of borrowing from the retirement fund, such as the loss of interest on the amount borrowed, possible fees, other opportunity costs.  Also, there is a limit of half of the balance or $50,000 maximum you can borrow from the account, so that will only go so far towards the cost of the college expenses.

However, there are many “pros” if you have started early enough and have built up a “comfortable” amount in your 401(k). 401Khelpcenter lists these pros as: 1. There are usually no restrictions, 2. the interest you pay you are paying to yourself, 3. it is convenient, 4. the wait is not long to get the loan, and 5. you are choosing where the money is coming from. If you have planned ahead and saved prudently, then you can, if you choose to do so, borrow from your 401(k) to help pay for college expenses— if the pros outweigh the cons.  Instead of risking your future and having a “YOLO” attitude about life and retirement you can successfully “SITUP!”

Diana K. Powell

Diana K. Powell, Esq. joined Westminster Consulting in September 2012 as Senior Legal Advisor. Previously she was a sole practitioner who advised educational organizations, government bodies and private corporations. Diana was responsible for negotiating agreements for high-tech software corporations...

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