Using a 401K Loan to Pay for Graduate School

Using a 401K loan to pay for graduate school is possible, but it should not be considered unless you cannot otherwise find the funds. 401K loans carry a number of risks that make them unattractive and not strong loan choices. Other loans, such as federal student loans or private student loans are usually better options. If you cannot get the funds elsewhere, for example if your credit score is very low, then you may consider a 401K loan in order to meet your tuition requirements.

Steps to Receive a 401K Loan

You will need to apply through your employer for a 401K loan. Your employer manages your retirement account when you use the 401K option, so your employer will have to approve any loan or withdrawal on the amount. The funds are highly restricted due to their tax status and other features. Your spouse may have to sign off on the loan due to these restrictions. Not all employers allow 401K loans, and they are not required to by law. If your employer decides to fund the loan, you will typically only be able to borrow up to 50% of your total vested amount. Any funds that are not fully vested at the time you apply will not be accessible. 

Risks of a 401K Loan

If you lose your job, you get fired or the company goes bankrupt, you may have to pay off the loan immediately. If you do not have the funds to do this, your loan goes into default. The lender, your previous employer, can recover funds for the default from your existing 401K balance. Since the employer has so much control over these funds, they can even garnish your wages while you are still employed if you are unable to make loan payments.

Perhaps the biggest risk with a 401K loan, though, is how it may compromise the health of your retirement funds. A 401K is truly used to protect you when you can no longer work. When you take a loan against these funds, you may decrease your monthly contributions, and you will not earn interest on the money you have used for your loan. The result is a drastically depleted retirement fund.

Risks of a 401K Withdrawal

Another option many people consider to meet immediate expenses is a 401K withdrawal. This means you are taking the funds directly from your 401K account. First, this is usually only an option if you cannot take a loan. If you have reached your 401K loan limits or your company does not offer loans, it may be possible to withdraw funds directly. When you withdraw from your 401K, you have to pay taxes on the money since it was not previously taxed. Aside from taxes, if you withdraw before the age of 59 1/2, you will be subject to a 10% penalty. This means you will have to take out up to 30% more from your account than you need to pay for graduate school.

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