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Save for college in a 401k plan?

OceanIsleOceanIsle 169 replies9 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.
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Replies to: Save for college in a 401k plan?

  • cshell2cshell2 720 replies9 threads Member
    edited November 1
    Two things pop into my head. One, 401K loans are going to cost you in origination fees and interest. Yes. I know the interest is being paid to you, but it's still a cost above saving in a 529 which is in excess of the 5.6% that is attributed to your EFC from having the money in a 529 instead of a 401K, so the sheltering part doesn't really pan out.

    The other thing is the limit on 401K loans is 50K. That won't go very far for 3 kids.

    edited November 1
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  • OceanIsleOceanIsle 169 replies9 threads Junior Member
    edited November 1
    That’s a good point. $75 origination fee and 4.75% interest (currently).

    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.
    edited November 1
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  • Twoin18Twoin18 1682 replies17 threads Senior Member
    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.
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  • rickle1rickle1 2079 replies18 threads Senior Member
    I would also be concerned about potential taxable event due to loss of job. I realize you think your job is stable but nobody really knows if that's the case. A blend of qualified and non qualified planning is usually a good idea for many reasons. Get some current tax breaks (401k) but also have liquidity (non qualified planning). Most people don't realize you can actually access roth IRA contributions penalty and tax free pre 59.5 (not converted dollars - from traditional ira) because you've already been taxed on those dollars. Plain old vanilla non qualified or 529 (preferred for tax leverage) will help for college.

    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.
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  • mommdcmommdc 11507 replies31 threads Senior Member
    Doesn't the balance of a 401k loan become due immediately if you ever leave that job?

    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.

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  • RedhoundsRedhounds 55 replies1 threads Junior Member
    edited November 1
    But then you will be paying tax on the contribution (since it's going into the Roth post-tax) at your full marginal rate. The FAFSA deduction for the tax paid is, by definition, less than the actual tax paid and the loan is not a taxable event so Roth-401k contributions may not make sense for this specific scenario.

    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."
    edited November 1
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  • RedhoundsRedhounds 55 replies1 threads Junior Member
    And I agree with the others that the 401(k) loan isn't the most optimal plan
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  • cshell2cshell2 720 replies9 threads Member
    I don't know if this is universal, but our plan only allows one loan at a time and the maximum payback period is 5 years for a non-housing loan. If you pulled 50K you'd have to start paying back nearly $1000/month starting right away, so that would leave you 12K/year less to cash flow that you would still have if the money was in a 529.

    I can see it as useful for cleaning up the last of the final kids college costs though.
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  • cptofthehousecptofthehouse 29661 replies58 threads Senior Member
    You have to do the numbers. Are you going to be eligible for any financial aid for your kids? I've known families with Multiple kids in college, all going to private schools that got sizeable grants even though they made high income that wouldn’t get them a dime with just kid in college.

    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?




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  • OceanIsleOceanIsle 169 replies9 threads Junior Member
    edited November 1
    Thank you to all who have offered opinions.

    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.
    edited November 1
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  • OceanIsleOceanIsle 169 replies9 threads Junior Member
    edited November 1
    @cptofthehouse ,

    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.

    edited November 1
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  • twoinanddonetwoinanddone 23378 replies17 threads Senior Member
    Pick cheaper schools.
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  • OceanIsleOceanIsle 169 replies9 threads Junior Member
    edited November 1
    @twoinanddone , that is the plan. But when I said we will need to borrow for 75% of the cost, I should have instead said find a way to pay for (bc it’s not currently in savings). Increased work hours, selling some assets...those will all be part of the scenario.


    edited November 1
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  • thumper1thumper1 75486 replies3310 threads Senior Member
    I’m confused. How can you “over contribute” to a 401K plan? There is a dollar limit per year that you cannot exceed...isn’t there.

    @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.
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  • OceanIsleOceanIsle 169 replies9 threads Junior Member
    @thumper1 ,

    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.
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  • thumper1thumper1 75486 replies3310 threads Senior Member
    You know...you need to consider your retirement plans as well as your paying for college educations. By not putting money into your retirement accounts, and borrowing against them, you are (in my opinion) messing around unnecessarily with your retirement money.

    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.
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  • socaldad2002socaldad2002 1605 replies30 threads Senior Member
    mommdc wrote: »
    Doesn't the balance of a 401k loan become due immediately if you ever leave that job?

    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).
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  • cptofthehousecptofthehouse 29661 replies58 threads Senior Member
    I’m not recommending co-signed loans as they hamstring both you and your student for the life of the loan and each of you. I’m talking Parent PLUS loans which has insurance of sorts as i mentioned above

    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
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  • OceanIsleOceanIsle 169 replies9 threads Junior Member
    edited November 2
    Thanks, @cptofthehouse . I won’t borrow $50k from my 401k, more like $20k - $30k. I can make those payments without too much trouble.

    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).
    edited November 2
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  • cptofthehousecptofthehouse 29661 replies58 threads Senior Member
    Each of your kids will be allowed to borrow up to $27k in loans in their own names under Direct Loans. Starts out with $5500 freshman year, $6500 sophomore year and then $7500 for junior and senior years. That’s usually the max recommended to throw on an underclassman. That might take care of your borrowing dilemma.

    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.
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