Using my 401k to pay off student loans

[finnly]

I have about $40,000 in student loans at 9% that are just killing me. I've been trying to figure out a way to pay them off so that I can get to the point where I am saving more money. I started to think about my 401k. I have enough in there to pay off the student loans and then they would be gone. The problem is the 10% penalty for early withdrawal of the 401k funds. Being as there is only a 1% difference, does it make sense for me to pay off the student loans so that I can be rid of them?

[snafu]

finnly, the whole point of a retirement fund is having investments that continue to increase in value over the long term. You will need to fund your senior years for a very long time...just now retirees can expect to fund their expenses for 35 years. The money added in the early years is worth so much more over the very long term.

Cashing out Retirement paying penalty and income tax reduces the value significantly and will cause you so much more serious problems as a senior when the choice to increase income will not exist but expenses keep coming. I suggest that you list your expenses including interest rates in hopes strangers can see small leaks that might help you pay down those 9% student loans. Someone may be able to offer ways of increasing income to devote to SLs.

BTW, do you know the specific holdings in your 401k? What are the fees and MER costs?

[disneysteve]

It isn't 10% vs. 9%. It is 35% vs. 9%. You have to pay taxes on the 401k money also.

So does it make sense to take money at 35% to pay off a 9% loan? NO!!

It virtually never makes sense to cash out a 401k or to borrow against a 401k.

[Singuy]

Do you also pay taxes if you borrow against your 401k? I thought taxes/penalties are exempt if you borrow against 401k, and the interest you pay goes toward your 401k. You just can't invest into 401k during the repayment period.

If you are yielding 3.5% from your 401k but your interest is 9%, it actually makes sense to borrow from your 401k(but this is to borrow, as in taking a loan, NOT to cash out). The ONLY part that is subjected to taxation is the interest of the loan (ie. 40,000 x interest x tax bracket).

It all depends on your 401k yields, and how great your company matches. I doubt you are yielding greater than 9% (but according to Dave Ramsy, everyone will eventually have a 13% return so we can all become millionairs with $100/month).

If your company matches, then I would just find other ways to lower your 9% interest(ie, borrow from parents and giving them 4.5% interest rate as you repay..which is way higher than their crappy CDs). When a company matches and if it'll take you 5 years to repay your 401k loan, then you'll be missing out on a LOT of money which is not worth it.

[disneysteve]

Do you also pay taxes if you borrow against your 401k?

Not exactly but in a way you do. The money that you contribute to your 401k goes in pre-tax. The money you use to repay a 401k loan goes in after-tax, but then that money gets taxed again when you withdraw it in retirement, so you end up being double taxed on that money.

If you are yielding 3.5% from your 401k

If your 401k is only earning 3.5%, you're doing something wrong.

If your company matches, then I would just find other ways to lower your 9% interest(ie, borrow from parents and giving them 4.5% interest rate as you repay..which is way higher than their crappy CDs). When a company matches and if it'll take you 5 years to repay your 401k loan, then you'll be missing out on a LOT of money which is not worth it.

Great point and another reason to never cash out or borrow from your 401k. The match, in most cases, is a guaranteed 50% return on your investment. That is phenomenally better than any outstanding debt you may have (except for things like payday loans and income tax refund loans).

Just go on the principle that you should NEVER take money out of your 401k except in retirement.

[Eagle]

I have about $40,000 in student loans at 9% that are just killing me. I've been trying to figure out a way to pay them off so that I can get to the point where I am saving more money. I started to think about my 401k. I have enough in there to pay off the student loans and then they would be gone. The problem is the 10% penalty for early withdrawal of the 401k funds. Being as there is only a 1% difference, does it make sense for me to pay off the student loans so that I can be rid of them?

Short answer: Don't touch your 401k. Live frugally and cut your expenses to the bare minimum. Try to get a promotion at work or make extra money by getting a second job. Either snowball your debt (pay off the smallest loans first) or avalanche your debt (pay your highest interest loans first).

[bUU]

The real question is why you cannot pay off these student loans with current income. Doing it that way is going to avoid all the concerns voiced in the messages above. Too often I think people see the pool of money in their 401k and think to take the easy way, but paying off debt is naturally hard work. It may require substantial sacrifices: Moving to where you can take public transportation to work, resting during vacations instead of traveling, compromising on clothing choices to save money, etc.