Years ago, due to a layoff, my friend faced the dilemma of cashing in his 401-K Plan for his kids education or letting them take college loans. Today this is a common dilemma many parents face. Seventy five percent of parents report a willingness to delay retirement to help their kids get through college. It is expected by 2024, ~25% of those 65 and older will either be working or looking for work, almost twice as many as in 1984. This significant increase is due in part due to the out of control and escalating college tuition cost. Unless you have excess savings, parents are risking their future by withdrawing large sums of money from their 401-Plans versus having their kids take out college loans.

As a Dad, I want what is best for my daughter, even if it means some sacrifice.
I believe majority of parents sacrifice for their kids. I know my parents did and I am grateful. Fortunately my parents did not have to decide to sacrifice their retirement money and neither did I for my daughter. But college tuition has soared to six figures and for some private schools close to $500,000. Before making that sacrifice, lets look at some facts.

TAX CONSEQUENCES AND PENALTIES

• Majority of 401-K plans do allow hardship withdrawals. You may be required to document you have exhausted all other college funding options.
• 401k withdrawals are subject to taxation at your ordinary income tax rate. If you are still working, and your kids are entering college you are likely at your peak earning years and therefore paying a higher tax rate.
• For those less than 55 years, 401k withdrawals are ALWAYS subjected to a 10% early withdrawal penalty. {Individual Retirement Accounts (IRAs) offer an exception to the early withdrawal penalty for college expenses.}
• All 401k withdrawals are reported as income in the year that you make the withdrawal, increasing your Adjusted Gross Income (AGI) and possibly increasing your tax bracket. This income increase could also reduce financial aid eligibility in a future academic year.
• Some 401k programs allow parents to borrow from there 401ks, as opposed to taking withdrawals. While a 401k loan initially sounds like an option, there are a few issues to consider:
o Most 401k-loan programs only allow you to have one loan outstanding at a time. Therefore, you must borrow whatever you need to cover all four years of college all at once (up to a maximum of $50,000).
o Furthermore, most 401k loans must be paid back within five years. If you’re borrowing enough to cover four years of costs and paying it off in five years, you’re actually not saving much in terms of monthly cash flow over simply paying the four years of costs as they arise over four years. If you can afford to pay back your 401k loans in a five-year time frame, you can probably afford to pay for college out-of-pocket and don’t need to borrow at all.
o In addition, the benefit to utilizing a 401k is that you get to set aside money on a pre-tax basis. If you borrow a 401k loan, you pay yourself back with AFTER-TAX money. A 401k provides no separation of after-tax loan payments from pre-tax contributions, so when you begin withdrawing from your account in your golden years, you have to pay taxes on the after-tax portion of your withdrawals again! We certainly don’t want to pay taxes TWICE on any money!

TODAY’S REALITY

Accepting significant penalty and tax cost you can sacrifice your welfare in retirement and use your 401k for your kid’s college. The question is: Should you?

We live in a world where majority of my readers and Americans have not adequately saved for retirement. If you do not have a substantial pension, you must live on social security, what you saved in your 401-K and Individual Retirement Account (IRA) and continue working if necessary. Your health will only allow you to work for a limited period of time.

If you CANNOT afford to withdraw from your retirement accounts, work with your children to strategically reduce cost and borrow what is necessary. There are a number of ways to successfully manage college costs without tapping a 401k.
• If finances are a concern, as they are for most of us, be sure your child applies to colleges where they will qualify for significant need-based financial aid or are likely to be recruited with sizable scholarship offers.
• Public, IN-STATE colleges, including public honors colleges, can be an economical alternative to pricier private schools.
• Starting out at a local community college can be an effective means to reduce college costs substantially.
• Most colleges offer a monthly payment plan so that parents can budget the tuition bill over the course of the year.
• There are a number of student and parent loans available to help pay for college.
• Also, insist they research the job prospects prior to enrolling in a major. There is ZERO reason to get a degree in “THE DUMBEST AND MOST USELESS THING IN AMERICA”. Why go into tens of thousands of dollars debt to drive for Uber or work for Starbucks?

CONCLUSION

There are ZERO loans available to finance your retirement. Unless you want to be dependent upon the good will of your children in your golden years, you may want to think twice before tapping your 401k to pay for their college. Consider if, in the long run, you are really doing your children any favors. And you best hope they remember all the good things about you and not that one bad day! Yep- they still remember that one (actually it was 13) bad days!

Why do you work so hard? Why do you save and accumulate wealth? For me, love is my primary motivation. I want to take care of the people I love as long as possible, including me!. So I understand your desire to do anything to help your children. Just keep in mind; your decision to withdraw retirement funds may come with consequences you did not intend. If you cannot take care of yourself in retirement, how much burden will you place on your kids. Think carefully about the question I asked. SHOULD YOU USE YOUR 401-K or IRA To FUND YOUR CHILD’S COLLEGE? Sit down with your spouse, CPA/Financial Advisor and your children and look at all the facts, the total cost and the consequences. Finally, the most important question you need to ask yourself before tapping retirement dollars is: “Will I need this money for my retirement?” For most of us, the answer to this question is – YES! Very few of us have overfunded our retirement accounts. With life expectancies on the rise, you may be looking at supporting yourself for 30+ years in retirement. With the current uncertainty in our Social Security system, 401k’s may become a primary provider of retirement income. Before tapping your retirement savings, think about this decision carefully and make the best decision for EVERYONE impacted!

DISCLAIMER
I am a proud nerd (my beautiful wife and daughter told me so) investment and finance blogger, with a Rutgers, MBA and Harvard, Advanced Management. I am a successful investor in equities and real estate and happy to share my personal finance and investment lessons learned with you. I am NOT however, a licensed financial advisor. Please do not construe my suggestions on this blog, as recommendations for your personal situation. For individual finance advice please seek your own licensed CPA or financial advisors.