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Save for college in a 401k plan?
OceanIsle
237 replies10 threads Junior Member
Now hear me out, please. I’m not talking about a hardship withdrawal.
Is it a terrible idea to front-load my 401k with a plan to loan myself the money for some of my kids’ college expenses in a few years? I do have (small) 529 plans set up for my kids but those count as parental assets and don’t reduce our federal taxable income.
I will have three kids in college at once soon. I already have co-signed on some small loans for child #1 after we used her 529 funds. Loans will be part of our journey, unfortunately.
I’ve recently increased my hours at work to increase savings for college. Should I divert that extra income temporarily to my 401k versus their 529 plans?
My thoughts:
- job is secure (owned by family members and I’ve been employed there over 20 yrs).
- 401k allows loans and permits ongoing contributions while repaying the loan.
- Reduces taxable income
- 401k balance sheltered from Financial Aid formula (unlike 529)
- No credit check, no affect on credit for debt to income ratio
- No penalties for early pay off
- Would be contributing the extra already earmarked for college costs (not “raiding” my retirement, though I may dip into that slightly)
-Interest is paid to myself vs. a bank or lender
- If college plans change then I’m not stuck with extra money in a 529; it’s saved in a retirement vehicle.
Is this feasible? I’m no accountant so I definitely could be missing something.
I am willing to delay my retirement in order to help lessen the loan burden on my kids (and lessen my co-signing tab).
Thanks for your insight.
31 replies Is it a terrible idea to front-load my 401k with a plan to loan myself the money for some of my kids’ college expenses in a few years? I do have (small) 529 plans set up for my kids but those count as parental assets and don’t reduce our federal taxable income.
I will have three kids in college at once soon. I already have co-signed on some small loans for child #1 after we used her 529 funds. Loans will be part of our journey, unfortunately.
I’ve recently increased my hours at work to increase savings for college. Should I divert that extra income temporarily to my 401k versus their 529 plans?
My thoughts:
- job is secure (owned by family members and I’ve been employed there over 20 yrs).
- 401k allows loans and permits ongoing contributions while repaying the loan.
- Reduces taxable income
- 401k balance sheltered from Financial Aid formula (unlike 529)
- No credit check, no affect on credit for debt to income ratio
- No penalties for early pay off
- Would be contributing the extra already earmarked for college costs (not “raiding” my retirement, though I may dip into that slightly)
-Interest is paid to myself vs. a bank or lender
- If college plans change then I’m not stuck with extra money in a 529; it’s saved in a retirement vehicle.
Is this feasible? I’m no accountant so I definitely could be missing something.
I am willing to delay my retirement in order to help lessen the loan burden on my kids (and lessen my co-signing tab).
Thanks for your insight.
Replies to: Save for college in a 401k plan?
The other thing is the limit on 401K loans is 50K. That won't go very far for 3 kids.
Part of the overall picture is that I’ve been over-contributing to my 401k for a while now (which is a good thing) but in hindsight I think I need that money for college.
So I guess another question would be should I take the future excess 401k contribution and divert to a 529 plan. This isn’t huge money we are talking about but it adds up.
I've seen folks use the 401k the way you suggest. It's just a bit risky so be careful. Also, the 50k limit doesn't help you too much.
And it might decrease your AGI if you contribute on a pre-tax basis, but it won't reduce income counted for EFC.
If you have enough retirement savings, maybe not contributing for a few years might be better?
Or contribute to a Roth IRA if you can.
EDIT TO ADD--I was responding to the thread above that said "Pre-tax savings in the years which count for FAFSA/CSS Profile will raise your contribution compared to post-tax savings (since you get a deduction in the formula for tax paid). So if you do continue to save in a retirement account once your kid(s) get to that stage then it is better to use a Roth 401(K) if available."
I can see it as useful for cleaning up the last of the final kids college costs though.
How much are you going to need for each year of the college years? Is the $50k max you. Can borrow going to cover what you need.? Do you you have multiple 401ks so you can borrow more if you need more? If you can get all you need borrowing from the 401ks, that’s fine.
We borrowed through PLUS. A total of $160k plus interest which we paid off in about 14 years. If either Borrowing parent or kid dies before loan is repaid, outstanding balance is forgiven so there is an insurance component to these loans covered by the interest rate charged.
There are many families who hold off on 401k contributions during college paying years.
I’m not sure what you mean about “excess” 401 k contributions. Excess in that you don’t get an employer match, or excess in that you don’t that amount for retirement? If you are more than comfortable in your retirement savings, then it makes sense to divert those contributions to something like college that is not otherwise affordable.
Families take any number of strategies to meet college costs. It’s a personal decision which ones to take. Some simply only consider colleges that are affordable with current income. Some have savings earmarked. If your strategy of saving for college is what drove your 401 k contributions, great Borrowing , if enough to bridge the gap, looks good to me. In fact, borrow and contribute to 529 plans and get a state deduction if it’s available for your state.
Do realize that contributions to a traditional 401k are added back to AGI for financial aid purposes, if that is something that matters.
So, are you expecting to qualify for financial aid during college years? How much do you expect to borrow each year from 401k?
I don’t have a Roth 401k but I do have a Roth IRA, which I have maxed out yearly for about five years but am re-evaluating all of these decisions moving forward in light of the overall household needs.. Those contributions can be withdrawn without penalty for college but any withdrawals count in the financial aid formula as income, which is definitely weighed heavier than assets in the formula. Not ideal.
The current 401k contributions count as income but once they are in there (and paid back in the form of loan payments), they are hidden from the FA calculation.
I’m thinking maybe $20,000 - $30,000 for this purpose. Not sure if that changes anything.
Also relevant, child #1 attends a meets full need college, but there are still (understandably) financial responsibilities to the family in our COA.
I definitely expect to qualify for financial aid during those years. Child #1 gets a large need-based grant equivalent to almost full tuition. We’ve been told that it will increase further as siblings enter college concurrently. (We’ll see).
When I said excess 401k contributions, I meant above the employer match. Right now I’m contributing 16% of my salary and they only match a portion up to 6%.
With that said, I do not feel that we have a comfortable amount set aside for retirement given unknowns, but we have enough where I’m comfortable diverting some to help our kids.
Co-signing loans at 7.5% is frightening to me and I’m concerned that it will eventually tank my credit score. I guess that’s why I’m brainstorming alternatives, such as loaning some money to myself via 401k. In a worst case scenario where I lose my job and the balance becomes due immediately, I could take it from my Roth without penalty.
Child #2 will likely attend a state school but we will have to borrow (whether from 401k or elsewhere) for about 75% of his costs.
Child #3 has the stats for generous merit and/or a college that is generous with need, but that’s never a given until we get there. There will likely be loans for her.
@BelknapPoint
As noted, any contributions you make to a tax deferred retirement account will be added back in as income for financial aid calculation purposes for that year.
Over contribute wasn’t the right phrasing. I have increased my contributions to my 401k significantly since increasing my hours (and with each salary increase), and instead of putting that extra money into a 529 plan, I’ve been adding it to my 401k for the past few years. By over contribute, I meant “put my extra savings.”
Although this year’s 401k contributions are added back in as income in the FA formula, they are also counted as income if diverted to my 529 plans except I lose the federal tax deduction for those funds. After this year, the saved money isn’t counted as an asset, whereas the 529 plan contributions continue to be.
Perhaps looking at more affordable colleges would be an option...or places where your kids will get significant merit aid could be an option. The merit aid idea would not take your income and assets into consideration at all.
No, the outstanding balance of the loan must be paid back by the due date of your federal income tax return, including extensions.
So lets say you leave your job November 1st, 2019 with a 401K loan balance. You don't have to pay it back until October 15, 2020, almost one year later. These rules were put in place under the 2017 Tax Cut Jobs Act (TCJA).
Your students will have Direct loans available in their names only in amounts starting at $5500 as freshmen
What concerns me about your Diverting 401k savings is that you are not where you want to be in this regard. Easy to say few of us are. But that is an issue to reconsider when borrowing from it.
I’m still not understanding how borrowing $50k from a 401k is going to achieve your objectives with your kids. Do you have multiple 401ks ? Will you be able to make the repayments?
Overall, you seem to be in a good place to make these determinations. You have savings, you understand the rules and implications of borrowing. You are proceeding carefully. Paying for college , saving for retirement have a lot of options. Sometimes we don’t want to take the most affordable options, the most pragmatic pathways. Glad that you are reviewing the situation
The Parent Plus Loan gives me pause bc of the large fee (4.75% or something) off the top. I was able to get more favorable terms with my bank (lower fixed rate, no origination fees, assurances that the debt is dismissed in the case of death).
I do hate the idea of co-signing private loans but my main goal is to have a portion of the college debt in my kids’ names (have myself removed from the loans once they make enough on time payments). If we are able to help pay them off later, we will do so.
Without knowing which of my three kids will owe how much (or if they won’t owe anything), I’m not ready to make a determination on how much of their respective debt will be in their names versus only in mine.
I do realize that co-signing means I’m ultimately responsible.
So I guess this comes down to deciding whether to offset some of the private loan or Plus loan amounts with a 401k loan.
With all of this said, I may look more at the PLUS loan too. I know that the 401k loan won’t affect or rely on my credit score, so maybe I should hold off on that 401k route until it is necessary. (Right now my credit score is high but I believe taking on debt will lower it).
Do not co-sign without checking out those loans v-e-r-y carefully. They have no insurance aspect most of the time. They hamstring you both credit wise and for pay back.