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Can I Use a 401k to Pay for College?

With the astronomical cost of higher education, it could be tempting to put off your own retirement.

The cost of college has been steadily rising for decades. According to CNBC, the tuition cost of a private, four-year degree was $31,000 in 2015 — up from $1,800 in the early 1970s. Two years later, in 2017, it’s over $33,000. And that’s before the fees, room, and board. It’s an incredibly daunting price tag, and you might be tempted to stave off your own retirement and dump your own 401K into your kid’s education.

But the experts say, generally, don’t do it. “A 401K can be used for college,” says Krista Cavalieri, CFP, of Evolve Capital. “But depending on when the expenses are incurred, it may mean paying an additional penalty. The bigger issue here is that any money used from the 401K for this purpose is less money for retirement, and you can only put so much money into this account each year.”

No matter the circumstances, taking money from your 401K will accrue a 10 percent early withdrawal penalty if you’re under 59-and-a-half years old — so paying for college with your retirement funds will be penalized. “Plus, you’ll owe the taxes on it right then and there,” says Ryan Frailich, founder of Deliberate Finances. “Your $10,000 withdrawal just became $6,000 or $7,000 real quick.” In 2011, only 4 percent of people drew on their 401K or IRA to pay for college, and for good reason. “You’re putting your own financial future at risk to fund something that has other funding options,” Frailich says.

It is possible to take out a loan from your 401K to pay for college. But that can be tricky. “In many cases this loan can be up to $50,000, or 50 percent of your 401K balance, whichever is lower,” says Mark Boujikian, CFP and financial planner with Keymark Financial. “You then have to pay your 401K back with interest. In most cases, you have a five-year payback window which makes it tough on your take-home pay. Without incredibly careful planning, there are way too many potential pitfalls for most to execute this without a problem.”

A much better idea would be, as Frailich alluded to above, to look for other funding options — of which there are many. “Your child can get a loan for college, but you cannot get a loan for retirement,” says Boujikian. The first funding option should be from your own savings from a 529 plan.

A 529 plan is a savings plan from a state or educational institution specifically for college, and it works much like a 401K or IRA, with you investing in mutual funds or similar investments. “You get tax-deferred growth on your savings so long as you use it to pay for qualified school expenses, and in many states, you get a state tax deduction as well,” says Frailich. “That’s a much better way than raiding your nest egg to cover expenses that you’ve had a long time to plan for.”

There are tons of loans, grants, and other short-term funding options for parents looking to send their kids to college, but Boujikian advises to start saving early so that you don’t need them. “Open the 529 when you start having the conversation about having a child,” he says. “You can open the account in your own name and then when your child is born and you have his or her social security number, you can switch it over to their name. In the meantime, you can start saving well in advance. Start funding $25-a-month automatically from your checking account.” He recommends a low-cost plan such as the State of Utah, which will allow you to invest based on the kid’s age to grow the funds and take advantage of compound interest.

So start saving yesterday. With some careful planning — plus all the other emergency funding options out there — you shouldn’t have to dip into your own nest egg for your kid’s college.