Parental Loans for Learning

Borrowing from Your Qualified Retirement Plans

You may be able to take a hardship withdrawal from a qualified retirement plan to pay for tuition and related fees for post-secondary education.

Avoid taking a hardship withdrawal until all other options have been exhausted.

Withdrawals from IRAs

The 10% penalty tax that applies to most withdrawals from a qualified retirement plan before the account owner reaches age 59½ will not apply to withdrawals from an IRA, either Traditional or Roth, for qualified higher education expenses of the taxpayer, spouse, children, or grandchildren.

Qualified higher education expenses include tuition at a post-secondary educational institution, books, fees, supplies, and equipment. The amount of the IRA distribution cannot exceed the qualified higher education expenses for the taxable year.

Borrowing from Your Retirement Plan

Many companies allow employees to borrow from their 401(k) or other qualified retirement plan. But remember: This is a retirement fund first and foremost! We usually recommend that you save for your retirement first—it is the single largest commitment you have to fund. So if you are going to borrow from your or your spouse's 401(k) plan, do it knowing it will get in the way of your retirement plans.

Since your loan is secured by the 401(k) plan, Department of Labor rules won't let you borrow more than 50% of your vested account balance.* There are also certain tax rules that limit the amount you may take as a loan without it being considered a distribution. Under current tax law, a 401(k) plan can permit you to borrow as much as $50,000 or half of your vested benefits in the 401(k) account, whichever is less. If your vested account balance is at least $10,000, you can borrow up to $10,000 even if 50% of your vested account balance is less than $10,000. If your vested 401(k) plan account is less than $10,000, you can borrow up to your vested account balance. The following chart summarizes these borrowing options:

Your vested account balance

The maximum you could borrow is …

$0–$10,000

Your vested balance

$10,000–$20,000

$10,000

$20,000 and higher

50% of your vested account balance, not to exceed $50,000

Loan terms are usually no more than five years for general purpose loans. Loans must be paid back on a regular basis—quarterly, monthly, or biweekly, but at least once each quarter.

IMPORTANT NOTE: When you borrow from your 401(k) plan, you no longer earn investment returns on the amount you borrow from the account. In effect, that money is no longer in the 401(k) plan earning money—you have borrowed it and it is out doing something else. So, although the interest you pay on the loan goes back into your 401(k) account, the true cost of the loan is the amount you would have earned on that money had you not borrowed it from the account. It is what we call opportunity cost and it is a tricky concept. It is true that "you're paying yourself back," but that's not all that's happening—you are also missing out on the investment earnings on those funds that were borrowed!

On the flipside, borrowing from your 401(k) loan can work to your advantage if the market is losing money. By pulling the money out as a loan, you're not participating in a losing market.

*Your vested account balance is the amount of your contributions, plus some percentage of any employer-matched contributions, depending on the length of your service with the company.

Share Article:
Add to GooglePlus
Investment and insurance products and services are offered through INFINEX INVESTMENTS, INC. Member FINRA/SIPC. Investment & Insurance Services at Flagstar Bank is a trade name of Flagstar Bank. Infinex is not affiliated with Flagstar Bank. Certain insurance products are offered through Douglas Insurance Agency, doing business as Flagstar Investment & Insurance Services, which is affiliated with Flagstar Bank. Products and services made available through Infinex are not insured by the FDIC or any other agency of the United States and are not deposits or obligations of nor guaranteed or insured by any bank or bank affiliate. These products are subject to investment risk, including the possible loss of value.
BrokerCheck