Even if you have investments and savings, using credit for large purchases and big expenses may make more sense when you consider your overall financial picture.
Safeguard your retirement savings
Most retirement plans allow you to borrow from your account and repay the funds over time. Before you tap into your retirement savings to pay for a large purchase or expense, consider:
- The costs of early redemption fees, penalties, and taxes for accessing retirement money prematurely
- Repayment requirements — some plans require loans to be repaid within 5 years or within 90 days if you change or lose your job.
- If you withdraw from your retirement savings, those funds are no longer growing and earning interest.
Compare your options
In this scenario, a family in the 25% tax bracket needs $30,000 to pay for a student’s college expenses.
Here’s what they need to consider.
Option 1: Withdrawing funds from a retirement plan
|Activity ||Amount |
|Withdrawal ||$50,000 |
|10% early withdrawal penalty (if under age 59 1/2) ||$ 5,000 |
|Income tax on the withdrawal ||$12,500 |
Amount left for college expenses
- Withdrawal normally has to be paid back within 5 years, so payments may be steep.
- A reduction of $50,000 in your retirement savings also decreases the compound interest that could be earned, equating to as much as $15,989 (calculated at 6% x 20 years) lost.
- Due to taxes and penalties, in order to net $30,000, you would need to withdraw roughly $50,000 depending on your age and tax bracket. (Source: 401(k) Early Withdrawal Costs Calculator)
- Some plans allow you to borrow against your retirement, rather than doing a straight withdrawal. Read the restrictions carefully to ensure you understand all of the terms involved.
Option 2: Consider a private student loan
|Private Student Loan||$30,000
|Loan payment 15-year loan at 5.99%
||$253.16 a month/$3,038 a year
|Amount for college expenses
- Over the 15-year life of the loan, you’ll pay roughly $15,568 in interest.
- The interest paid on a student loan may be tax-deductible.
- Payments are deferred until 6 months after student leaves school.
- Your retirement savings may grow uninterrupted.
Source: Student loan payment calculator
Speak with your tax advisor and financial planner to understand all the options and implications before you tap into your retirement savings.