Is Using 401(k) For Student Loans a Good Idea?

University education is very expensive, especially in the United States. Little wonder most people resort to Loans when considering how to fund their undergraduate or graduate programs at the university. If you are a student that intends to use 401(k) for student loans, this topic on 401(k) is for you.

401(k) for student loans
401k-for-student-loans. Photo by Shane on Unsplash

What is 401(k)?


A 401(k) is a contribution account that takes advantage of your tax, to cut out a savable percentage. This is a plan that takes advantage of employees’ total salary before taxation and takes a particular amount so it could go into their 401(k) savings account.

These accounts are set up for the employees and have their names after a section of the U.S. Internal Revenue Code. Workers who make use of 401(k)’s accounts can make contributions directly to their accounts. They do this through an automatic payroll set up by their employers who can match some or all of those contributions.

How does the 401k work?

You know, as you work, you get paid into a salary account. And as you receive this payment, your taxes come in and reduce your take-home by some percentage. However, if you run a 401(k) account, there is a difference. The percentage set aside for deduction is calculated before tax is removed.

This means that you would ordinarily save more money through this method than after-tax deduction. This method allows workers to save more from their salaries than they would normally do after taxation.

And that is why this has become a growing option for workers. And the government is encouraging this method to keep people afloat.
The money saved into a 401(k) account goes in there as an investment avenue for pensions/retirement.

The 401(k) is not just a savings wallet. When the criteria are met, it can be used as a borrowing purse. In cases of a financial crisis, 401(k) can be an option. This way, a worker can take a loan from his 401(k) account. The loan is usually given only if it is at most, 50% of your account, or $50,000 in total. This way, they keep a tab on the limit to which borrowers can access.

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How Can I get a loan through 401(k)?


If a worker wants access to a loan from his account, there are some criteria that he has to reach. Firstly, the borrower has to ensure that the loan is for a short-term purpose. Such term purposes such as an immediate need for cash, an emergency, etc are such reasons.

However, many financial experts think taking a loan from 401(k) is a bad idea. They argue that taking loans from one’s retirement plan is a direct attempt to cripple the purpose of the account. They argue that indiscriminate loans for purposes such as hosting an event or planning a vacation are obscene.

However, it is general knowledge that loans from 401(k)’s are better and smarter options for short-term and immediate loans. This is because 401(k) loans are tax-free and attract less interest than other kinds of loans.

Ted Benna, who founded the 401(k) idea had a realization in the late 1970s. He found a way to help workers save more for their retirement than they already were. However, it was until the 1980’s that the government chose to adopt the idea.
Today, it is the biggest saving pattern for workers globally.

Who can use 401(k)s?

Anybody who has a paying job can make use of the 401(k) retirement system. They can always ask their employers to set them up for this. The employee is determined if fit by the IRS.

This is because the IRS handles all 401(k) loans because they are funded through the government and could contribute to a borrower’s credit history. Such employees are however advised to be certain to not make it a habit of requiring a loan from their 401(k) consistently as it can negatively affect their history.

Can One Use the 401(k) for Student Loans?

Also, the question of what purposes the 401(k) loan is suitable for remains a constant one. Many times, workers are always in need of money. Such could be for purposes like rent, bill payment, loan offset, and the like. However, one key question has been if 401(k)’s is a good means to pay off student loans.

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Well, we can tell you that that isn’t such a good idea.
Ordinarily, the 401(k) was designed to ensure that workers have a reliable means of saving the most they can. This was why the method became a viral option. The inclusion of the loan system was born out of the urgent need for cash that workers often experience. Therefore, the 401k is suitable for immediate and short-term loans. Particularly, it is a bad idea to borrow to pay off loans.

Consequently, using 401(k) for student loans is also a bad idea. This is because student loans is a long-term loan that is advisable to be paid overtime rather than just once. While paying off college debts at once is such a great idea, taking a loan from your 401(k) for that is not.

This is also because paying off debts does not add any extra cash to the payer. And as such, would leave a huge gap in the borrower’s retirement plan. This would also attract penalties, one of which is damaged credit history.

When Can I Use my 401(k) Money?

Ideally, after retirement. When you reach retirement age, you can begin taking withdrawals without incurring any penalties.

Unless it’s a Roth account, you’ll most likely have to pay income taxes though.
You must begin making necessary minimum distributions, sometimes known as “mandated minimum withdrawals,” after you age 72.

Conclusion.

Especially for those who have bulk sums as tuition debt, using your 401(k) for student loans is a terrible idea. Particularly because of how unstable retirement plans can be, taking a loan from them isn’t such a good idea. This is because the inability to pay off the loan could arise as a result of job loss and that will set back the entire plan. This ridicules the entire process from its purpose.

In essence, taking a loan from your 401(k) contribution account is a smart option, if you need a quick fix for cash. And it is best to be in smaller amounts payable as soon as possible. However, longer-term loans are a terrible idea for the 401(k) option. Loans such as student loans, mortgages, long-term business investments, etc are loans that the 401(k) does not fit. So if you plan to make use of your 401(k) loan option to pay off student loan debt, you might need a rethink.

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FAQs Is Using 401(k) For Student Loans a Good Idea?

Is 401(k) a good means to pay off student loans?

Using 401(k) for student loans is not advisable.

Can you use 401k to pay your student loans?

Is There a Penalty for Paying Student Loans from a 401(k)?
No, unless you are 59½ years old or older, you will be penalized if you remove money from your 401(k).
Early withdrawals are subject to income tax and a 10% penalty.

What is the downside to borrowing money from your 401k?

However, there are several significant drawbacks to 401(k) loans.
Even though you’ll pay yourself back, a significant disadvantage is that you’re still taking money out of your retirement account while it’s still growing tax-free.
Additionally, less money in your plan means less money that will increase in value over time.

What is the interest rate on a 401k loan?

The rate is often one or two points higher than the prime rate.
Your 401(k) borrowing rate will be between 6.5 percent and 7.5 percent since the prime rate is now 5.5 percent.
The fact that the interest rate is the same regardless of your credit score is one of the main factors in why so many individuals are drawn to 401(k) loans.

How long do I have to pay back a 401k loan?

Five years

How long do 401(k) loans have to be repaid?
A 401(k) loan typically has a five-year repayment period, but if the money is being used to purchase your primary house, the duration may be extended to 25 years.

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