How to Use a 401K to Pay for College Tuition

How to Use a 401K to Pay for College Tuition. Tapping into a 401K retirement fund to pay for college tuition of children is a possibility. However, a 401K is not really designed for that purpose, and you have to carefully look at the cost of using funds from your 401K plan versus all of the other available options before making a decision. With the cost of college education running close to $13,000 a year at 4-year public universities and more than $30,000 per year at private ones, you may not have a choice but to dip into a 401K fund, especially if you have multiple children going to college at the same time.

Instructions

    • 1

      Apply for a loan from your 401k fund and use that to pay for college expenses. Whether or not you can do that depends on the plan in which you are enrolled. While it's not required that the plan allows a loan, most do. Generally, you can borrow up to $50,000, or half the account value, whichever is lower.

    • 2

      Avoid job changes for the duration of the loan. Typically the loan is repayable in 5 years, with interest. If you switch jobs, you will need to repay the loan amount immediately--typically, within 60 days. If you fail to do so, you will lose the tax exemption benefit. The loan is considered a taxable distribution and you will need to pay a 10 percent penalty on top of that. However, when you are paying back the loan with interest, it goes back to your account and you receive it back when funds are disbursed at retirement.

    • 3

      Request a hardship withdrawal. IRS allows withdrawal from a 401K account under an "immediate and heavy" financial need. The financial need must be imminent and all other options must have been exhausted before you can make such a withdrawal. The amount you can use may be limited to your contribution only, and you will be subjected to a 10 percent early withdrawal penalty. There are other stipulations as well. Typically, it's very hard to qualify for such a withdrawal, and demonstrating that paying for college tuition is a "heavy and immediate" financial burden could be challenging.

    • 4

      Compare the tax liability and penalty costs of closing a 401K account versus other options. If you have a 401K and have a low yearly income, collapsing the account might push you to a higher tax bracket and you will also have to pay a penalty.

    • 5

      Roll the 401K into an IRA and withdraw from the IRA when you need it. You can do this if you have some time before you will need the money to pay for college tuition. This will save you the penalty, though you still have to pay taxes on the withdrawals.

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