Tap into 401k or take extra loan money

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el William
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Tap into 401k or take extra loan money

Postby el William » Wed May 16, 2012 11:09 am

I am trying to make prudent decisions regarding paying for law school (duh!), but I am not exactly a financial whiz.

I am going to need to take out some loan money for books, health insurance, new computer, and a few other necessities. This is on top of the $20,000 Stafford loan which will cover just about my entire tuition. By my calculations I need about $11,000 in gradPLUS loans to make ends meet this year, and I anticipate needing less in coming years (probably $6,000 or less in the final two years, but at this point it is hard to know for sure).

I currently have a 401k worth about $4,200 and my question is, should I empty my 401k to pay for some of these expenses or should I roll it over into an IRA and take out extra loan money? I have always been told that saving for retirement early is smart decision (again, duh!) so I have been contributing to this 401k for as long as possible. I have been getting an 8-10% return on my investment which makes me think that I would be better off leaving that money alone so that it continues to grow, while taking out extra loans which will accrue interest at 6.8%. But is the calculation really as simple as that? I wonder if maybe I am missing something. Should I count on the fact that I hope to make more money in the future and can thus effectively save for retirement post law school? I know that employment prospects are grim right now so that seems like a bit of a gamble. The main advantage to using the 401k comes from the fact that using it for educational expenses allows me to take the money out tax free, whereas if I need it in the future to help make ends meet (read: make payments on a huge student loan amount) I would take a 20% hit on the overall balance.

TL;DR I know...

Any thoughts?

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dingbat
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Re: Tap into 401k or take extra loan money

Postby dingbat » Wed May 16, 2012 1:09 pm

There have been quite a few threads on this, so I'm going to give you the quick answer

It is highly unlikely, in the current economic climate, that, on a tax adjusted basis, the return on investments earned within your IRA will be greater than the cost of the student loan.
Therefore, the smart option is to take money out of your IRA rather than borrowing more

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Tiago Splitter
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Re: Tap into 401k or take extra loan money

Postby Tiago Splitter » Wed May 16, 2012 1:15 pm

401k withdrawals will not be tax free. They will also not be penalty free if taken directly from the 401k as there is no higher education expenses penalty exception on qualified plans. Even worse, there will be a 20% mandatory tax withholding on any distributions from a QP. Your best bet is to roll the 401k into an IRA and take the withdrawal from the IRA. This avoids the mandatory withholding and allows you to take the penalty exception.

Assuming the 401k money is pre-tax and not Roth try to wait until January to take it out so the income taxes will be a bit lower.

Also, Gradplus loans are 7.9%, not 6.8%.

el William
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Re: Tap into 401k or take extra loan money

Postby el William » Wed May 16, 2012 1:32 pm

Tiago Splitter wrote:401k withdrawals will not be tax free. They will also not be penalty free if taken directly from the 401k as there is no higher education expenses penalty exception on qualified plans. Even worse, there will be a 20% mandatory tax withholding on any distributions from a QP. Your best bet is to roll the 401k into an IRA and take the withdrawal from the IRA. This avoids the mandatory withholding and allows you to take the penalty exception.

Assuming the 401k money is pre-tax and not Roth try to wait until January to take it out so the income taxes will be a bit lower.

Also, Gradplus loans are 7.9%, not 6.8%.


Thanks for the response.

I am planning on rolling it into an IRA before requesting the withdrawl. Can you explain a bit more about the taxes being lower if I wait until January?

Also, am I mistaken that there is a higher education exception for withdrawls from an IRA?

Lastly, would you consider it a good option to remove the money from the IRA or would it be better to take the loans and let the IRA grow?

Thanks to dingbat too, I should have thought to search the forum before posting this question.

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dingbat
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Re: Tap into 401k or take extra loan money

Postby dingbat » Wed May 16, 2012 1:39 pm

Don't thank me - I'm too lazy to rehash the same arguments again

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gossipgirl
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Re: Tap into 401k or take extra loan money

Postby gossipgirl » Wed May 16, 2012 1:51 pm

el William wrote:
Tiago Splitter wrote:401k withdrawals will not be tax free. They will also not be penalty free if taken directly from the 401k as there is no higher education expenses penalty exception on qualified plans. Even worse, there will be a 20% mandatory tax withholding on any distributions from a QP. Your best bet is to roll the 401k into an IRA and take the withdrawal from the IRA. This avoids the mandatory withholding and allows you to take the penalty exception.

Assuming the 401k money is pre-tax and not Roth try to wait until January to take it out so the income taxes will be a bit lower.

Also, Gradplus loans are 7.9%, not 6.8%.


Thanks for the response.

I am planning on rolling it into an IRA before requesting the withdrawl. Can you explain a bit more about the taxes being lower if I wait until January?

Also, am I mistaken that there is a higher education exception for withdrawls from an IRA?

Lastly, would you consider it a good option to remove the money from the IRA or would it be better to take the loans and let the IRA grow?

Thanks to dingbat too, I should have thought to search the forum before posting this question.


Are you working this year? If so, your income in 2012 will likely be higher than your income in 2013 during your 1L/2L year.

When you take from your 401k, you need to pay income taxes on it. Taking it out in the year where your income is less means you will have less of a tax burden so wait until January to take from the 401k.

As to 401k vs loan, it's a financial calculation you have to make.

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Tiago Splitter
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Re: Tap into 401k or take extra loan money

Postby Tiago Splitter » Wed May 16, 2012 2:11 pm

I'm with dingbat on the main question. I'll be taking money out of my retirement accounts to pay for law school.

Higher education is a penalty exception on IRA distributions but not on 401k distributions. Just different sets of rules. Gossipgirl answered the wait until January question perfectly. Presumably your income will be higher in 2012 than in 2013, but if not then it makes no difference.

el William
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Re: Tap into 401k or take extra loan money

Postby el William » Wed May 16, 2012 2:18 pm

Thanks for the responses everyone. It definitely makes sense to wait until January; that is great advice that I did not even think about at first.

Ii looks like I am going to take the money from the IRA in January. If anyone has a well-reasoned response that refutes this idea please share.

el William
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Re: Tap into 401k or take extra loan money

Postby el William » Wed May 16, 2012 2:31 pm

I thought of another question.

Will waiting until January make a difference in taxes regardless, or will it only matter if the amount that I am withdrawing is enough to push me into a different tax bracket?

I currently work in a crap retail job so income is pretty minimal and the 401k is relatively new and as I stated earlier, only worth about $4,000.

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dingbat
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Re: Tap into 401k or take extra loan money

Postby dingbat » Wed May 16, 2012 2:35 pm

Depends on your income and deductions.
In all lokely hood next year will be better, but without more details than you'd want to share online we can't tell you for sure

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Tiago Splitter
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Re: Tap into 401k or take extra loan money

Postby Tiago Splitter » Wed May 16, 2012 2:38 pm

el William wrote:I thought of another question.

Will waiting until January make a difference in taxes regardless, or will it only matter if the amount that I am withdrawing is enough to push me into a different tax bracket?

I currently work in a crap retail job so income is pretty minimal and the 401k is relatively new and as I stated earlier, only worth about $4,000.


Many people do unpaid work during 1l summer, and its very possible that your income for all of 2013 will be zero. In that case, a 4000 dollar distribution will be effectively tax free. During 2012, you'll be taxed at your current rate.

jim-green
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Re: Tap into 401k or take extra loan money

Postby jim-green » Mon May 28, 2012 8:03 pm

I have a similar question, I need to decide by August whether to take a loan or spend $20 K from (non-retirement) savings on tuition. I will be paying sticker, so tuition will be $50. But should I take $30 K in loans and pay $20 K in cash, or do a loan for the whole amount?

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dingbat
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Re: Tap into 401k or take extra loan money

Postby dingbat » Mon May 28, 2012 8:08 pm

jim-green wrote:I have a similar question, I need to decide by August whether to take a loan or spend $20 K from (non-retirement) savings on tuition. I will be paying sticker, so tuition will be $50. But should I take $30 K in loans and pay $20 K in cash, or do a loan for the whole amount?

Why would you borrow money (and pay interest on it) if you don't have to?
It's like throwing mobey into the toilet.

I can't think of a single good reason to do that (unless you need the cash for something, like maybe a downpayment - which is a whole nother argument)

jim-green
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Re: Tap into 401k or take extra loan money

Postby jim-green » Mon May 28, 2012 8:13 pm

dingbat wrote:
jim-green wrote:I have a similar question, I need to decide by August whether to take a loan or spend $20 K from (non-retirement) savings on tuition. I will be paying sticker, so tuition will be $50. But should I take $30 K in loans and pay $20 K in cash, or do a loan for the whole amount?
Why would you borrow money (and pay interest on it) if you don't have to?
It's like throwing mobey into the toilet. I can't think of a single good reason to do that (unless you need the cash for something, like maybe a downpayment - which is a whole nother argument)
I just thought of keeping the money for safety. Maybe I am wrong.

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dingbat
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Re: Tap into 401k or take extra loan money

Postby dingbat » Mon May 28, 2012 8:19 pm

jim-green wrote:
dingbat wrote:
jim-green wrote:I have a similar question, I need to decide by August whether to take a loan or spend $20 K from (non-retirement) savings on tuition. I will be paying sticker, so tuition will be $50. But should I take $30 K in loans and pay $20 K in cash, or do a loan for the whole amount?
Why would you borrow money (and pay interest on it) if you don't have to?
It's like throwing mobey into the toilet. I can't think of a single good reason to do that (unless you need the cash for something, like maybe a downpayment - which is a whole nother argument)
I just thought of keeping the money for safety. Maybe I am wrong.

Keeping money for safety is an excellent idea, but don't keep more than you need (I'd say a few thousand)

jim-green
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Re: Tap into 401k or take extra loan money

Postby jim-green » Mon May 28, 2012 8:26 pm

dingbat wrote:
jim-green wrote:
dingbat wrote:
jim-green wrote:I have a similar question, I need to decide by August whether to take a loan or spend $20 K from (non-retirement) savings on tuition. I will be paying sticker, so tuition will be $50. But should I take $30 K in loans and pay $20 K in cash, or do a loan for the whole amount?
Why would you borrow money (and pay interest on it) if you don't have to?
It's like throwing mobey into the toilet. I can't think of a single good reason to do that (unless you need the cash for something, like maybe a downpayment - which is a whole nother argument)
I just thought of keeping the money for safety. Maybe I am wrong.

Keeping money for safety is an excellent idea, but don't keep more than you need (I'd say a few thousand)
Thank you, that is a good compromise, exactly what I was looking for, and excellent advice. Makes me feel better about the whole thing, now I have an idea of what to do.

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dingbat
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Re: Tap into 401k or take extra loan money

Postby dingbat » Mon May 28, 2012 8:29 pm

jim-green wrote:
dingbat wrote:
jim-green wrote:
dingbat wrote:Why would you borrow money (and pay interest on it) if you don't have to?
It's like throwing mobey into the toilet. I can't think of a single good reason to do that (unless you need the cash for something, like maybe a downpayment - which is a whole nother argument)
I just thought of keeping the money for safety. Maybe I am wrong.

Keeping money for safety is an excellent idea, but don't keep more than you need (I'd say a few thousand)
Thank you, that is a good compromise, exactly what I was looking for, and excellent advice. Makes me feel better about the whole thing, now I have an idea of what to do.

If you ever have a question about money/finance/banking/insurance ask away - I know more about it than most people on this board (and most people in general, for that matter)




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