Withdraw 401k for living expenses while in school?

Aliareza, BSN · Jun 23, 2015

It truly depends on your situation. It can really hurt you at tax time to do something like this. The only way I'd advise it is if you know you're going to have extra room and can avoid paying so much of the penalty. I'll give you my real life example.

My husband quit his job last year to go back to school. He'd been working there for 7 years, so he was fully vested and had $9000 in his 401k. He took the payout. Right off the top, they took 20% of it, which they are allowed to do. 10% covers taxes, 10% is a penalty fee for early withdrawal. The tax portion, we mostly got back, because our combined income was $10,000, so even with the payout, we only "made" about $20,000 last year. I had a lot of dental bills (needed a lot of work, had no dental insurance), so I claimed ~$3,000 in medical expenses on my taxes.

This is where they double-dip to screw you over. Even though the $9,000 in 401k distribution was not earned income, it contributed to the amount we had made (our AGI). I had to get over a threshold that was 10% of my AGI, and anything over that, I could claim to reduce the early-withdrawal penalty. That left me with not very much. The government took about $1000 of the $9000 between leftover taxes and the withdrawal penalty. We also would have qualified for earned income credit of ~$400 had we not had that extra income from the 401k distribution. Even though it was not "earned", the government counted it and denied us the earned income credit.

It was very worth it for us because we still got about $7,500 of it in the end, and the extra $1,500 the government took was what my husband's company had vested him anyway. We gained money. Most people are not poor enough to benefit in that way, and even though we were, he still lost $9,000 toward retirement, and that's something we'll have to spend a lot of time making up for.

I never would have touched it had there been any other plausible way to send both of us to school, but there wasn't. Now I'm a nurse, and my annual salary is $45k. Putting off school to work a min wage job and save up for tuition would not have been worth the wasted time where I could have been earning a much higher salary. Your long run almost definitely looks different from mine, though. For most, it would never be worth it to withdraw from a retirement fund.

AllIcanbe · Jun 23, 2015

Thanks everyone! So glad I could read other's opinions...because a payroll deduction is needed for 401k loans; I know a 401k loan is not feasible since I will not be fully employed with my current employer once classes start

I am planning on working a part time job in addition to my regular job to save towards living expenses once school starts but a colleague said my federal loans may take a hit if I make too much money....

I can not defer school for right now as I am getting close to 40 and need to get school out of the way.. I also got admitted to a school very close to me so I dont wanna loose that opportunity.

I am researching grants/ scholarship and I see few options... I will keep exploring my possibilities ï¿½ï¿½

Jory, MSN, APRN, CNM · Jun 23, 2015

It will end up costing you far more in the long run.

WrekDiver88 · Jun 26, 2015

I funded part of my ABSN with my IRA, and am planning on doing the same with grad school. I think with a 401k you can loan yourself the money, but it has to be paid back within 5 years or something to avoid the 10% early withdrawal penalty (at least that is the way it used to be I am pretty sure). With an IRA on the other hand, you can take the money out penalty free up to the COA of the school, as well as for some other uses such as 10k towards a first time home purchase.

If eligible, what you can do is roll your 401k into an IRA (I did this with my 403b when I left my last job), then the money would be useable for school. Also, if you plan ahead, put extra money into an account you can roll into an IRA; an IRA itself has somewhat low caps per year, usually 5k at the max unless you are older, but based on income the tax deferred amount scales down, is why I am suggesting using an employer option, then rolling over when leaving.

The biggest advantage to this (besides loan interest), is that you get the write off now, while you have income, lowering your taxes, and putting the money into the account tax free, then withdrawing it while you are in school with no income, and student credits, which will usually allowing a tax/penalty free withdrawal. Who doesn't like tax free money!

AllIcanbe · Jun 26, 2015

Thank you WrekDiver 88! So will I have to pay back the loan with interest into the IRA over a period of time ? This sounds like something doable ...

WrekDiver88 · Jun 27, 2015

No, if taken out of a 401k, it would be a low interest loan to yourself, that would need to be paid back to the 401k (within 5 years I believe). If taken out of traditional IRA, it is a penalty free withdrawal that does not ever need to be paid back, as long as you use it for qualified educational expenses (up to the COA per year). You only need to pay the income tax on the money (it was tax deferred when you put the money in the account), but if you are in school full time with no income, the tax credits for being in school should cover the tax owed on the withdrawal making it a tax (assuming you don't take a very large amount out in one year) and penalty free withdrawal you do not need to pay back.

If you have a 401k at your current employer, you can usually roll it into a traditional IRA when you leave that job, which would allow you to use this tax advantage. I would call the advisor for any 401k(s) you have and ask about your options for a rollover.