What are you going to do with your 401K?

Question

I wonder whether there is a way that I can use the 401k to pay for my tuition without paying the extra 10% tax.

Or, would it be better to use the loan and to leave the 401K alone so that it can accumulate a return which is typically higher than the interest of the student Loan?

Mark4124 · Answer

I'm cashing mine out and paying off some college credit card debt. But yes... education actually is a withdrawal that can exempt you from the 10% early withdrawal penlty. It needs to be post secondary and accredited... I would imagine business school would fit the bill. Check the IRS. I used to work in 401k for Fidelity. We didn't deal with the taxable implications... thats your responsiblity at tax time.

Hjort · Answer

You might want to verify that 401(k) distributions used to pay higher education expenses are excepted from the 10% additional tax. 

Please see IRS Topic 558- Tax on Early Distributions from Retirement Plans. 

The following exceptions apply only to distributions from IRAs: 

Distributions equal to or less than your qualified higher education expenses, 
Distributions made to pay for a firstâ€“time home purchase, and 
Distributions made to pay health insurance premiums if you are unemployed.

Mark4124 · Answer

Yeah... the first one on your list.

But you qualify that at tax time. Your IRA provider will automatically withhold 20% from any distribution. If you wish to get around the withholding and pay the tax at tax time you need to roll over to an IRA where you will not have a manditory withholding but can withhold 10% + if you wish from your distribution.

Mark4124 · Answer

opps... 401k provider

OasisNYK · Answer

I think you might have to roll it over into a roll over ira before you do that - unless you can just do it direct from a 401k. But my girlfriend just did this to pay for the rest of her college (she is a senior) and she will be tax exempt from the 10% rule - however you must keep in mind that if you use it to pay for education and you pull it from your IRA that it will count as income and you will have to pay taxes on that.

Having them withhold some money for taxes at the end of the year is a smart idea (unless you dont have much in your IRA then it probably doesnt matter).

But it is something I am contemplating as well.

rhyme · Answer

Interesting. I had no idea I could tap 401k. Wonder if I can tap SEP-IRAs as well. I have far more in the SEP-IRA than the 401k, just because I was self employed for a long time. I've got almost two years tuition sitting there.

Mark4124 · Answer

Difference between the 401k and the IRA is the "manditory withholding"

IRA: No Manditory withholding, optional 10% or greater withholding

401k: Manditory 20% withholding 

Come tax time... Same taxable implications... Ordinary income + 10% for early withdrawal unless an exemption applies...

I have worked in both 401k and brokerage... I know what I am talking about guys.

Mark4124 · Answer

And for these purposes a SEP should be the same as any old IRA. SIMPLE-IRAs have different rules but SEPs should be the same.

died4me · Answer

Mark, thanks a lot! Fidelity :-D

That's where my money is collecting handsome interest. :lol:

I definitely need to do some reseach on this to make best use of the little money I have in the 401K. (about 1yr's tuition)

Mark4124 · Answer

Tough call always... taxable distribution, reduction in potential of your money to make money, the money is currently tax defered. If I didn't have alot of debt from college I don't think I'd do it... but of course that is a situation that is very, very individual.

jamesrwright3 · Answer

I would not do it unless the amount you have in there is minimal
I wouldn't play with my retirement money unless you have credit card debt
Otherwise, the interest gained in the account ( if you are aggressive) will outweight the interest rate on any loans

Hjort · Answer

Since the federal govt. subsidizes at least part of the loan package for most students it probably makes more sense to borrow at this subsidized rate and leave the 401(k) account alone. For CC debt, investigate your refi options.

For what it is worth (not much), this is technically an exception, and not an exemption.

The difference in treatment between a 401(k) and IRA with regard to education expenses is a dangerous trap for the unwary as discussed in the Domanico case below. In the Domanico case, the taxpayer mistakenly believed that 401(k) plans were excepted from 10% additional tax in accordance with the provisions of IRC Section 72(t). The US Tax Court found that the taxpayer was indeed obligated to pay the 10% additional tax.

https://www.ustaxcourt.gov/InOpHistoric/ ... um.WPD.pdf

Mark4124 · Answer

Thats an interesting case. The ruling seems to come down mostly to timing. She tried to offset a 2001 distribution with educational expenses for subsequent years and the court found that the exemption only applied to the year of distribution. That does make sense. Her 401k is not the typical case in that one is forced to take immediate distribution or roll. In most 401ks (at least most Fidelity 401ks) you don't have to take a full distribution all at once or roll. I've seen a few but it isn't all that common. Most you are in the clear if you have over 5000, a typical de minimus amount. But certainly if you were in her situation you should have rolled to an IRA and taken distributions as need in THE SAME YEARS AS YOU INCURRED THE EDUCATION EXPENSES. Thats interesting though Hjort, I'll read the rest of it later... Cool case.

rhyme · Answer

What the heck... are all your guys accountants or something!! ?

rhyme · Answer

If I'm reading the PDF correctly, this woman took money from a 401k because she bought a book at borders that said she could - not because she actually read any tax laws --, got told she couldn't because a 401k is a qualified retirement plan and not subject to the exception, but IRAs would be only because of the technical difference between the two?

Mark4124 · Answer

A 401k is a qualified retirement plan... I'll read the whole thing later but it seems like her problem came in that she had to take a full distribution or rollover. She took that full distribution but the higher ed expenses where not in the year she took the distribution but rather in subsequent years. You can't claim an exemption for future years. You get an exemption for the year of the distribution. Her argument seems to be that she was forced to take a full distribution so she had no choice but to do it that year and because she had to take a full distribution rather than partials she should get the exemption. Thats stupid because you can roll it over and take the money as needed. 

Going to school in 2007...
Roll over 401k or keep in 401k if you can take partials...
Take some in 2007 for 2007 expenses and claim the exemption if it was all used in 2007. 
2008 take some more for 2008 expenses and again take the exemption for the 2008 expenses... blah, blah...

Not take it all in 2007 and say "well I'm gonna use it for higher ed in the next 2 yrs so I will exempt the amount I expect to use" Wrong. Doesn't work like that. You need to match the distribution year to the expense year. 

The IRS doesn't play games and doesn't let you play games either. Unless the law says you can do it I would never come up with "my own creative approach." The IRS doesn't deal in creative approaches. You do things their way or you are screwed.

Hjort · Answer

I agree with Mark- it is a bad idea to play games with the IRS. Domanico's reliance on the CCH Tax Guide is a good reminder not to believe everything we read, even when it comes from an established commercial publisher. 

IRAs and 401(k)s are both forms of qualified retirement plans. However, at least with respect to Section 72(t), 401(k) plans are NOT considered a form of "individual retirement plan".

rhyme · Answer

Ah yes, clearly subject to Section 84(q) 1034(h) w2 nonexempt tailored two person deduction under the "You guys know too much about this stuff" tax act of 1892.

FN · Answer

very interesting indeed...

my mom was suggesting that i take money out of my 401K, buy my aprtment from her (this would be my first and primary residence). She would then loan me the money i paid her for the down payment, on an interest free basis...and i could use that pay for my tuition...I would take the tuition loan to pay my mortgage...

though, i am now debating if fidelity (my 401k) would deduct 20% holdings from my account. Mind you, I am not withdrawing my entire 401k, about maybe 30% of it.

What are you going to do with your 401K?

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