Can You Use Your 401(k) to Pay Off Student Loans?

Using your 401(k) to pay off student loans can diminish your nest egg.

Using your 401(k) to pay off student loans can diminish your nest egg.

You've earned your degree and maybe landed a decent job. The problem is you now also have tons of student loan debt. If you're like the average college graduate, your debt is probably $20,000 or more. Your 401(k) has enough dough to pay off your loans and it seems like a great idea. For most young people, however, tapping into the retirement account might do more damage than good. Only under extreme circumstances will the IRS let you withdraw without penalties.

Employer Contributions

You usually can't take out what your employer has put into your 401(k) as part of a matching deposit program. This money is typically off limits when you want to make a withdrawal to pay off a debt. Any deposits that you make, however, are eligible if your withdrawal request meets IRS rules. A financial hardship falls under those rules, but your plan may exclude existing debt from its eligibility list.

Financial Hardship

The IRS defines a hardship as an immediate and significant financial need. This means that you have no other way to pay for something that is life-threatening or life-sustaining. Typical examples of eligible hardship expenses include hospital bills, mortgage or rent payments, tuition expenses, funeral and home repair costs. Mortgage or rent payment must be for your primary home, and 401(k) money is usually used to prevent foreclosure or eviction. If you already have enough money from a job, a regular savings account or other investments, that may make your expenses ineligible for a 401(k) withdrawal.

Early Withdrawal

You may choose to go ahead and withdraw your 401(k) money without hardship. You'll pay taxes on the withdrawal because it's considered income. The IRS will also charge a 10 percent penalty if you're younger than 59 1/2. If the interest rate on your student loan is less than 10 percent, this may not be the best option. You'll lose future interest earnings on your 401(k) balance and end up paying more in taxes. Keep in mind that most of your student loan interest is tax deductible.

401(k) Loans

Instead of taking out your 401(k) money, you can borrow against it. This may be a better choice if you want to get rid of your student loans. You'll have to pay your 401(k) loan back with interest, but it might be lower that your college loan's rate. Some plans don't allow loans. The IRS will let you borrow up to 50 percent of your vested balance, up to a $50,000 maximum. You'll have five years to pay it back, unless you leave your employer. If you leave, you'll usually have to pay it back immediately.

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About the Author

Helen Akers specializes in business and technology topics. She has professional experience in business-to-business sales, technical support, and management. Akers holds a Master of Business Administration with a marketing concentration from Devry University's Keller Graduate School of Management and a Master of Fine Arts in creative writing from Antioch University Los Angeles.

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