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401k loan to pay off student loans

Last Updated on August 12, 2023 by Oluwajuwon Alvina

Bankruptcy usually gets pitched as a last resort but no matter your situation or the severity of your problem, bankruptcy is not always your answer. Why? In this author’s opinion, so many of us spend every bit of spare money we have on our personal debts and when they don’t work out, there’s nothing left to build savings. If your debts aren’t being paid off fast enough, then getting a 401k loan can help you out. I spent most of my 20s working in the construction trades, but finally achieved full-time employment as a software engineer when I was 29. I paid off all but one of my college loans by the time I was 30 (due to debt forgiveness at age 30 under the Public Service Loan Forgiveness program). That’s an extra $150,000 that otherwise would have gone towards student loan debt. That makes me $28,000 richer and all for less than an hour’s worth of salary! I’ve since taken on another company and have been paying off my student loans at a slightly slower pace. It still feels good to save money for the future.

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401k loan to pay off student loans

Many people who are currently in school or have recently graduated from college find themselves saddled with student loan debt. These loans can be a heavy burden, and can make it difficult to save for retirement. We offer a solution that kills two birds with one stone: take out a 401k loan to pay off your student loans!

This is not as crazy as it may sound—it’s actually pretty popular in the financial industry right now.

Let’s break down exactly why this makes sense. One of the biggest issues with student loans is that you can’t discharge them in bankruptcy—they will stick around forever. If you use your 401k to pay off your loans, though, and you default on those loans (which happens more often than you might think), then it just means your 401k gets drained instead of your loan balance getting bigger.

It’s important to remember that as long as you’re paying back your 401k loan, interest rates on student debt will be much higher than what you’ll pay into your IRA account. But if you need some money right now and don’t want to wait until retirement age to get it? This is a great option!

Deciding whether to take out a 401k loan to pay off your student debt is no easy decision. You may have considered it, though, because of the benefits: you don’t need a credit check, there are no application fees, and you can use the money for any purposes.

But there are also serious downsides—and we want to make sure you know about all of them so that you can make the best choice for yourself and your financial future.

For example, if you leave your job while still paying back your 401k loan (that is, if you’re still within five years of taking out the loan), you may have to pay taxes on the full amount at once, which could lead to a huge tax bill. You could also be hit with a 10% early withdrawal penalty if you’re under 59 and a half years old.

Another important thing to know is that when you take out a 401k loan, you’re borrowing from yourself—which means that while the money is out of your account, it’s not earning interest or growing in value. So even if the interest rate on your student loans is high and your 401k loan interest rate is low, it’s important to remember that you’re missing out on gains in your retirement

Should You Use a 401(k) Loan to Pay Off Student Loans?

Learn how you can borrow from your 401(k) to help pay down student loan debt. Find out whether it is a good idea to take out a 401(k) loan, including how it will affect your retirement savings. Compare alternatives that are worth considering for reducing the financial strain caused by student loans.

Depending on your career path, getting the job you want may require a college education. But it’s no secret that tuition is expensive.

Fortunately, a student loan can provide the needed funds to complete your degree. But while these loans are helpful, there’s also the burden of repaying a loan over 10 to 20 years.

So it probably comes as no surprise that some people consider dipping into their 401(k) to pay off their loans.

Borrowing from a 401(k) can quickly eliminate student debt, but this isn’t generally advised by financial experts.

Even so, you may cringe at the idea of these seemingly endless payments.

If so, here’s what you need to know about borrowing from your 401(k) to pay off student loans.

How Do 401(k) Loans Work?

When you think of borrowing money, you likely imagine filling out a loan application, waiting for a credit approval, and then receiving your funds.

It’s different when you borrow from a 401(k).

A 401(k) loan doesn’t come from a bank, but rather from your own retirement funds.

For this reason, the process is much quicker than getting a traditional loan.

Applying for one

In fact, many employers make the process super easy.

To start the process, you’ll need to speak with your human resources manager, if this department handles the company’s benefits.

Or speak with your company’s 401(k) plan provider.

Because there’s little paperwork with this type of loan, you only need to complete a simple form.

You’ll provide your name, Social Security number, address, birthdate, and the amount you want to borrow from your account. You’ll also need to select a repayment term.

Since you are borrowing from yourself, your credit score doesn’t really matter for this type of loan.

Read the form carefully because it’ll provide other details and features of the loan. For example:

  • A 401(k) loan has a minimum and maximum borrowing amount. Minimums vary by employer. So you may only be allowed to borrow from the account if you’re pulling out at least $500 or $1,000. The maximum you can borrow is the lesser of 50 percent of the vested account or $50,000.
  • This is a loan and you’re required to pay back what you borrow plus interest. Since you’re borrowing from yourself, all interest goes back into your account. The interest rate on a 401(k) loan is usually the prime rate plus one or two percentage points.
  • A 401(k) loan must be repaid within five years. You’ll repay the loan through payroll deductions each pay period, which you’ve authorized on the loan form.

How They Affect You Negatively

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If you’re itching to get rid of your student loan debt and you have plenty of money in your 401(k), you may see no harm in borrowing from this account.

Maybe you’re still young and feel there’s plenty of time to recoup the money.

Because you’re paying back the account, you could also argue that a loan is far better than a 401(k) withdrawal. This is when you take money from your account without repaying it.

But while the above points are true, a 401(k) loan can have negative ramifications.

1. You’ll miss out on market gains

Borrowing from your 401(k) will decrease the amount of money in your retirement account.

Even if you borrow funds for a good purpose, less money in your account means you’ll miss out on market gains and compounded earnings—which you would have received if you left the funds in the account.

For example, if you have $30,000 in a 401(k) and you borrow $10,000, you’ll only earn gains on the $20,000 until you repay the loan.

Slower gains can also occur if you temporarily lower your 401(k) contributions while paying back your loan.

Putting less money in your retirement account also reduces how much your employer contributes, if the company you work for offers a match program.

2. You’ll pay penalties if you don’t pay back the loan

Even if you have every intention of paying back a 401(k) loan, you can’t predict the future.

And unfortunately, if you lose your job or quit before paying back the entire loan, you’re required to pay any remaining balance within 60 days.

Or else the 401(k) loan is considered a withdrawal.

A 401(k) withdrawal is subject to federal and state income tax, plus a 10 percent early withdrawal penalty if you’re under the age of 59 1/2.

Let’s say you’re in the 25 percent tax bracket and you borrow $10,000 from your 401(k).

If you only pay back $3,000 before leaving your job, you’ll have to fork over about $1,750 in federal income tax and pay a $700 penalty if you’re unable to pay back the remaining $7,000.

3. You’ll pay taxes twice

When you borrow from your 401(k), loan payments are made with after-tax dollars.

In other words, the money you put back into your account has been taxed.

This results in double taxation because you’ll also pay taxes on this money once you’re eligible to withdraw from your account in retirement.

4. You’ll lose access to financial hardship programs

When you use a 401(k) loan to pay off student loan debt, you also give up access to financial hardship programs.

These are typically available with federal student loans.

These programs help graduates who cannot afford their monthly student loans payments.

They’ll either receive a lower payment, or they’re allowed to stop making their loan payments temporarily without penalty.

If you get a 401(k) loan and can’t repay this loan, there are no hardship provisions available to help you.

The upside is that defaulting on a 401(k) loan doesn’t damage your credit score. Even so, failure to repay any remaining loan balance is considered a withdrawal. You’re then subject to taxes and penalties.

When Does It Make Sense to Borrow From Your 401(k)?

Despite the reasons “not” to borrow from your 401(k) to pay off student debt, there are certain situations when you might consider this option.

1. The interest rate on a 401(k) loan is lower

Interest rates on federal student loans are generally low, and may also be lower than the interest rate on a 401(k) loan.

But if you have a private student loan from a bank, you may be paying a higher interest rate.

If your student loan payments are too expensive and pose a financial burden, using your 401(k) to pay off this loan makes sense if the interest rate on your 401(k) loan is much lower.

Your 401(k) loan payments may also be lower than your current student loan payment, providing a little breathing room in your budget.

2. You have bad credit and cannot qualify for refinancing

Student loan consolidation or refinancing can help you get a lower interest rate and a lower monthly payment.

But qualifying for refinancing will likely require a credit check, and you may not qualify with a low credit score.

If you can’t qualify but desperately need a lower payment, using a 401(k) loan to off your student debt might be the solution.

Chances are, you’ll get a lower rate on your 401(k) loan.

And because a 401(k) loan doesn’t involve a credit check, you don’t have to worry about bad credit disqualifying you.

Alternatives to a 401(k) Loan

Allowing your retirement account to grow untouched can result in a well-funded account once you’re ready to retire.

So if possible, avoid tapping your 401(k) unless absolutely necessary, or only as a last resort.

If you leave your account alone, you might ask: What are my other options for getting rid of high student loan payments?

There are plenty of alternatives for more manageable payments.

Deferment and forbearance

As previously mentioned, federal student loans have hardship programs.

Therefore, contact your student loan provider to see if you’re eligible for a deferment or forbearance.

Both options will temporarily suspend your student loan payments, or lower your monthly payments in the event of financial hardship.

Your student loan lender can provide information on eligibility.

Compare Deferment vs. Forbearance

DefermentForbearance
Pros:You can postpone student loan repayment for an extended period of time, usually up to three yearsYou may not be responsible for paying accrued interest during defermentYou’re able to keep your loan in good standing and avoid defaulting on themAvailable for many federal student loans (a.k.a. government-funded loans)Pros:You can postpone repayment for a few months (usually 6 to 12 months)There’s no limit to the number of forbearances you can request (although you may not always get approved each time you request one)Federal student loans and private student loans are eligible
Cons:Some private student loans (a.k.a. bank-funded loans) may be eligible for deferment while you’re still in school, but deferment isn’t generally an option until after graduationQualifying for deferment typically depends on the type of federal student loan you have, so certain loans may not be eligibleThe total amount you repay over the life of your loan may be higher if you don’t pay interest while you’re in defermentDeferment is not a permanent option – you are still required to pay back your student loans, although you’ve received this temporary breakCons:You’re responsible for paying interest that accrues during forbearanceYour loan servicer may set a limit on the maximum period of time you can receive a general forbearanceForbearance is not a permanent option for your student loans – you are still required to pay them back, although you’ve received this temporary break

Personal loans

Another option is to get a personal loan to pay off your student loan debt.

This might be an option if your credit score is high enough to qualify for a loan, and you feel you can get a cheaper interest rate on a personal loan.

This can help lower your monthly payments without touching your retirement account.

Keep in mind, getting a personal loan to pay off a federal student loan means you’ll lose access to hardship provisions if you experience economic difficulties in the future.

Conclusion

When retirement is years away, you might think a 401(k) loan is no big deal since you’ll repay funds.

But dipping into your retirement account—even if only temporary—could cause you to miss out on market gains and reduce the strength of your nest egg.

So think twice before using these loans to pay off student debt. Consider other alternatives first.

And if you must touch your account, pay back what you borrow as soon as possible.

Taking out a loan against your 401(k) to pay off student loans may be a tempting option during financial hardship, but it can have long-lasting consequences.

The main benefit of taking out a 401(k) loan is that it is easy to obtain. Unlike alternative loans, you do not need to qualify by having sufficient income or a good credit score. Additionally, the interest rate is likely to be lower than what you are currently paying on your student loans.

However, the cons of taking out a 401(k) loan outweigh the benefits. For example, you will be charged interest on the loan, and usually at rates comparable to commercial bank rates. This means that even if you are paying less interest on the overall principal, you will still end up paying more in interest than if you had continued just making your regular payments on your student loans.

Additionally, when you take out a 401(k) loan and stop making contributions to your retirement account for the duration of the repayment period (typically five years), this can put a significant dent in your retirement savings.

hardship withdrawal for student loans

Should You Withdraw From Your 401(k) to Pay Off Student Loans?

Due to the rising cost of college, many graduates are saddled with large student loan payments upon graduation. Student loan debt repayment is a top priority for many people who are looking to take control of their monthly spending.

Student loan payments can put a major dent in monthly budgets, preventing people from focusing on other savings goals. When you have a growing balance in your 401(k) you may ask yourself “can I use my 401k to pay off student loans?”. Although it is possible to withdraw funds from a 401(k) retirement account, you should consider the impact it will have on your retirement and review other alternatives first.

Here we will explain the consequences of using funds from a 401(k) to pay off student loans and alternatives to explore.

Rules for Withdrawing From Your 401(k)

Can you use your 401k to pay off student loans? The short answer is yes, but since the funds in your 401(k) are meant for retirement, there are many rules for withdrawing funds prior to that time. It is important to fully understand the guidelines for withdrawing before using money from your 401(k) to pay off student loans. Here are the rules to know:

  • You will pay a 10% penalty tax for withdrawing money from your 401(k) if you are under 59 ½ years old.
  • You will need to pay federal income taxes on the withdrawn amount.
  • Some states may require you to pay state income taxes on the amount you withdrew.
  • An exception to the withdrawal penalty is an IRS guideline known as the rule of 55. If you are age 55 or later (or in the calendar year you turn 55) and leave your job for any reason, whether your own doing or by your company, you can withdraw funds from your 401(k) penalty free. You will still owe income taxes though.

Borrowing From Your 401(k)

If the 10% penalty discourages you from withdrawing from your 401k to pay off student loans, you may be able to borrow from your 401(k) instead. However, not all plan administrators provide the option of loans.

If loans are allowed, be sure to check with your plan administrator for exact details on amount allowed, interest rate, and time frame for repayment as these can vary. Here are the general IRS rules for borrowing to be aware of:

  • You can only borrow from vested funds in the 401(k).
  • There is a limit to how much can be borrowed, up to 50% of the vested amount or up to $50,000, whichever is greater.
  • You can borrow multiple loans as long as you do not exceed the maximum amount borrowed of $50,000 total.
  • Loans are not subject to income tax.
  • Loans generally have to be repaid in five years, although your plan administrator may have a different loan length.
  • According to the IRS, payments must be made in equal payments made at least quarterly and consist of principal and interest.
  • The interest payments are put back into your 401(k) since your vested money was used to make the loan.

Hardship Withdrawals

Although you may hear about hardship withdrawals when you are considering using your 401k to pay off student loans, hardship withdrawals are not permitted to repay student loans even if you are struggling to keep up with your monthly payments.

A hardship withdrawal is allowed for emergency needs, defined by the IRS as “an immediate and heavy financial need”. In some circumstances, using the money for college tuition may be allowed, but you would still owe income tax on the money.

Consider Early Withdrawal Penalties

Early withdrawals will result in a significant penalty, which can mean a hit to your retirement savings. Therefore, in order to net a certain amount, you need to factor in the penalty and income tax you will owe for the withdrawal. This is how early withdrawal penalties will affect you:

If you are under 59 ½ and do not fit the 55 rule exception noted above, you will owe a 10% penalty. Meaning if you withdraw $25,000, $2500 will be taken out for the penalty in addition income taxes will be owed on the full $25,000 come tax time.

Long-Term Risks of Using Your 401(k) to Repay Student Loans

Not only do you face the possibility of paying a penalty and owing additional income taxes when using your 401(k) to pay off student loans, but there are also long-term consequences such as missing out on compounding interest when the money is withdrawn. This will cause you to have less money for retirement.

Even if you repay the money or make additional contributions, you will be playing catch-up on your retirement savings. Also, consider your possible rate of return for your retirement account versus the interest rate you are paying on your student loans. There are ways to reduce your student loan interest rate and monthly payment to make it more manageable, so consider other options first.

Consider Other Options if You Are Struggling With Repayment

If you are struggling with student loan repayment, before you ask, “Can I use my 401k to pay off student loans?” consider other student loan debt relief measures. Here are some debt relief options to consider:

  • Income-Driven Repayment: If you have federal loans, consider applying for this type of plan, which calculates your monthly payment based on your income and family size.
  • Student loan forbearance or deferment: If you’re eligible, these options may freeze your federal student loan payments for up to a year based on different circumstances. Be sure to research whether interest will continue to accrue during this time.
  • Work with your lender: For private student loans, contact your lender about your difficulty with paying. Some may offer forbearance programs or temporarily reduce your payment.
  • Charities & donors that help repay student loans: If you are struggling with repayment, certain charitable or nonprofit organizations may be able to help.
  • Student loan forgiveness: Certain professions and sectors of work can qualify for student loan repayment assistance or forgiveness.

Alternatives to Repay Student Loans Faster

Student loan debt can be a burden, even if your monthly payment is manageable. If you are focused on paying off student loans early, there are other advantageous options and strategies to consider before tapping into your 401k to pay off student loans:

  • Student loan refinancing: Refinancing allows you to obtain a new student loan to pay off previous student loans. You may have the opportunity to lower your student loan interest rate and change your repayment term.
  • Withdrawing funds from an IRA: If you have a Roth IRA, you can withdraw your contributions at any age without the risk of penalty or taxes, as long as you do not withdraw any earnings. Withdrawing funds from a traditional IRA will result in an early withdrawal penalty if done before the age of 59 ½ just like with a 401(k).
  • Making extra payments: Whether with extra money from your budget or money you receive in a windfall, extra payments can help save on interest costs and knock your balance out quicker.
  • Starting a side hustle: Earning extra money outside of your day job can be a great source to pay debt off. Start with selling unused items around your house or picking up dog-walking jobs. Every little bit can help.
  • Create and stick to a budget: Determine how you spend your money and see if there are categories that can be eliminated or cut back to allow for more money to be put towards your loans.

Refinance Your Student Loans With ELFI Today

If you are determined to pay off your loans quickly, student loan refinancing is a great option.

There are many benefits of student loan refinancing, including the opportunity to lower your interest rate and change your repayment term. To get an idea of how much you could save, use ELFI’s student loan refinancing calculator.

pay off loan with 401k

Using Your 401(k) to Pay off a Mortgage

There are some understandable questions you might encounter as you plan for retirement: Is it sensible to be squirreling away money in an employer-sponsored retirement plan such as a 401(k) while simultaneously making a hefty monthly mortgage payment? Could it be better, in the long run, to use existing retirement savings to pay down the mortgage? That way, you’d substantially reduce your monthly expenses before you leave behind work and its regular paychecks.

KEY TAKEAWAYS

  • Paying down a mortgage with funds from your 401(k) can reduce your monthly expenses as retirement approaches.
  • A paydown can also allow you to stop paying interest on the mortgage, especially if it’s fairly early in the term of your mortgage.
  • Significant disadvantages to the move include reduced assets in retirement and a higher tax bill in the year in which the funds are withdrawn from the 401(k).
  • You’ll also miss out on the tax-sheltered investment earnings you’d make if the funds remain in your retirement account.

There’s no single answer as to whether it’s prudent to discharge your mortgage prior to retirement. The merits depend on your financial circumstances and priorities. Here, though, is a rundown of the pros and (compelling) cons of the move to help you decide whether it might make sense for you.Pros

  • Increased cash flow
  • Elimination of interest
  • Estate-planning benefits

Cons

  • Reduced retirement assets
  • A hefty tax bill
  • Loss of mortgage-interest deductibility
  • Decreased investment earnings

Pros to Discharging Your Mortgage

Here are the factors in favor of living mortgage-free in retirement, even if it means using up much or all of your 401(k) balance in order to do so.

Increased Cash Flow

Since a mortgage payment is typically a hefty monthly expense, eliminating it frees up cash for other uses. The specific benefits vary by the age of the mortgage holder.

For younger investors, eliminating the monthly mortgage payment by tapping 401(k) assets frees up cash that can be used to meet such other financial objectives as funding college expenses for children or purchasing a vacation property. With time on their side, younger workers also have the optimal ability to replenish the drawdown of retirement savings in a 401(k) over the course of their working years.

For older individuals or couples, paying off the mortgage can trade savings for lower expenses as retirement approaches or begins. Those reduced expenses may mean that the 401(k) distribution used to pay off the mortgage needn’t necessarily be replenished before leaving the workforce. Consequently, the benefit of the mortgage payoff persists, leaving the individual or couple with a smaller need to draw income from investment or retirement assets throughout retirement years.

The excess cash from not having a mortgage payment may also prove beneficial for unexpected expenses that could arise during retirement, such as medical or long-term care costs not covered by insurance.

Elimination of Interest

Another advantage of withdrawing funds from a 401(k) to pay down a mortgage balance is a potential reduction in interest payments to a mortgage lender. For a conventional 30-year mortgage on a $200,000 home, assuming a 5% fixed interest rate, total interest payments equal slightly more than $186,000 in addition to the principal balance. Utilizing 401(k) funds to pay off a mortgage early results in less total interest paid to the lender over time.

However, this advantage is strongest if you’re barely into your mortgage term. If you’re instead deep into paying the mortgage off, you’ve likely already paid the bulk of the interest you owe. That’s because paying off interest is front-loaded over the term of the loan. Use a mortgage calculator to see how this might look.Calculate Your Monthly Payment

Your monthly mortgage payment will depend on your home price, down payment, loan term, property taxes, homeowners insurance, and interest rate on the loan (which is highly dependent on your credit score). Use the inputs below to get a sense of what your monthly mortgage payment could end up being.ENTER HOME PRICE$ENTER DOWN PAYMENT$%SELECT LOAN TERM              30 years                      20 years                      15 years                      10 years         ENTER APROr Credit Score%OR             Your Credit Score                       760-850                      700-759                      680-699                      660-679                      640-659                      620-639         + MORE OPTIONSMONTHLY PAYMENT$ 1,969.22 /month for 30 yearsMonthly Payment$1,969.23Principal & Interest$ 1,351.56Property Taxes$ 506.67Homeowners Insurance$ 111.00Mortgage Size$304,000.00Mortgage Interest*$182,560.32Total Mortgage Paid*$486,560.32*Assuming a fixed interest rate. A variable rate could give you a lower upfront rate.

Estate Planning

Additionally, owning a home outright can be beneficial when structuring an estate plan, making it easier for spouses and heirs to receive property at full value, especially when other assets are spent down before death. The asset-protection benefits of paying down a mortgage balance may far outweigh the reduction in retirement assets from a 401(k) withdrawal.

Cons to Discharging Your Mortgage

Against those advantages of paying off your mortgage are several downsides—many of them related to caveats or weaknesses to the pluses we noted above.

Reduced Retirement Assets

The greatest caveat to using 401(k) funds to eliminate a mortgage balance is the stark reduction in total resources available to you during retirement. True, your budgetary needs will be more modest without your monthly mortgage payment, but they will still be significant. Saving toward retirement is an overwhelming task for most, even when a 401(k) is available. Savers must find methods to outpace inflation while balancing the risk of retirement plan investments.

Contribution limits are in place that cap the total amount that can be saved in any given year, further increasing the challenge.

For 2021, the 401(k) annual contribution limit is $19,500 and for 2022, the limit is $20,500. Those aged 50 and older can make an additional catch-up contribution, which is limited to $6,500 each year.1

With the passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act in December 2019, you can now contribute past the age of 70½. That’s because the act allows plan participants to begin taking required minimum distributions (RMDs) at age 72.2

Due to these restrictions, a reduction in a 401(k) balance may be nearly impossible to make up before retirement begins. That’s especially true for middle-aged or older workers and therefore have a shorter savings runway in which to replenish their retirement accounts. The cash flow increase resulting from no longer having a mortgage payment may be quickly depleted due to increased savings to make up a retirement plan deficit.

A Hefty Tax Bill

If you’re already retired, there is a different kind of negative tax implication. Overlooking the tax consequences of paying off a mortgage from a 401(k) could be a critical mistake. The tax scenario might not be much better if you borrow from your 401(k) to discharge the mortgage rather than withdraw the funds outright from the account.

Withdrawing funds from a 401(k) can be done through a 401(k) loan while an employee is still employed with the company offering the plan as a distribution from the account. Taking a loan against a 401(k) requires repayment through paycheck deferrals. However, the loan could lead to costly tax implications for the account owner if the employee leaves their employer before repaying the loan against their 401(k).34

In this situation, the remaining balance is considered a taxable distribution unless it is paid off by the due date of their federal income tax, including extensions. Similarly, employees taking a distribution from a current or former 401(k) plan must report it as a taxable event if the funds were contributed on a pretax basis. For individuals making a withdrawal prior to age 59½, a penalty tax of 10% is assessed on the amount received in addition to the income tax due.56

The Loss of Mortgage-Interest Deductibility

In addition to tax implications for loans and distributions, homeowners may lose valuable tax savings when paying off a mortgage balance early. Mortgage interest paid throughout the year is tax-deductible to the homeowner. The loss of this benefit may result in a substantial difference in tax savings once a mortgage balance is paid in full.7

It’s true, as we noted earlier, that if you’re well along in your mortgage term, much of your monthly payment pays down principal rather than interest, so it is limited in its deductibility. Nonetheless, homeowners—especially those with little time left in their mortgage term—should carefully weigh the tax implications of paying off a mortgage balance with 401(k) funds before taking a loan or distribution to do so.

Decreased Investment Earnings

Homeowners should also consider the opportunity cost of paying off a mortgage balance with 401(k) assets. Retirement savings plans offer a wide array of investment options meant to provide a way to generate returns at a greater rate than inflation and other cash equivalent securities. A 401(k) also provides for compound interest on those returns because taxes on gains are deferred until the money is withdrawn during retirement years.8

Typically, mortgage interest rates are far lower than what the broad market generates as a return, making a withdrawal to pay down mortgage debt less advantageous over the long term. When funds are withdrawn from a 401(k) to pay off a mortgage balance, the opportunity to earn money on the investments is lost until new funds replenish the 401(k), if it’s replenished at all.

The Bottom Line

Keep in mind that you enjoy the likely appreciation in the value of your home regardless of whether you’ve discharged its mortgage. Financially, you might be better off overall to leave the funds in your 401(k) and enjoy both their possible appreciation and that of your home.Compete Risk Free with $100,000 in Virtual CashPut your trading skills to the test with our FREE Stock Simulator. Compete with thousands of Investopedia traders and trade your way to the top! Submit trades in a virtual environment before you start risking your own money. Practice trading strategies so that when you’re ready to enter the real market, you’ve had the practice you need. 

can i use my 403b to pay off student loans

Legislation Would Allow Retirement Plan Withdrawals to Pay Student Loan Debt

While this seems counterintuitive to the effort to discourage leakage from retirement accounts, a summary of the bill states, “The quicker student loan debt is paid down, the sooner workers can focus on retirement savings.

Senator Rand Paul, R-Kentucky, introduced S. 2962, the Higher Education Loan Payment and Enhanced Retirement (HELPER) Act, aimed at helping Americans more quickly and easily pay off their student loan debt and save more money for retirement.

HELPER Act would allow Americans to annually take up to $5,250 from a 401(k), 403(b), 457 plan or IRA—tax and penalty free—to pay for college or pay back student loans. These funds could also be used to pay tuition and expenses for a spouse or dependent.  

The plan would enable two parents and a child, for example, to put over $15,000 in pre-tax funds in one year toward tuition or loan repayment if each set aside the maximum. “Currently, Americans can only pay for their student loans with after-tax money, placing an unnecessary constraint on their budget,” according to a news release from Paul’s office.

The bill would also allow employer-sponsored student loan and tuition payment plans to be tax free up to $5,250, and it would repeal the cap (and the phasing out) on deducting student loan interest, as student loans do not disappear when someone earns more money throughout their career.

While this seems counterintuitive to the effort to discourage leakage from retirement accounts, a summary of the bill states, “Because of student loan debt/repayment, workers are often not fully contributing to their [retirement plans] in the first place. The Paul bill changes the incentive to invest, since that money can be used to pay down burdensome debt. And the quicker student loan debt is paid down, the sooner workers can focus on retirement savings.”

To help give Americans the opportunity to save as much as possible for retirement, the legislation would also offer workers the choice to have an employer contribution to a retirement plan count as a Roth contribution. “While current law defers the taxes on employer contributions, forcing Americans to pay taxes on the funds and its gains in retirement, this change would allow workers to pay the taxes right away, freeing their savings to grow tax free and giving them greater financial security after they retire,” the news release explains.Previously, Senators Ron Wyden, D-Oregon, and Ben Cardin, D-Maryland, introduced The Retirement Parity for Student Loans Act, which would permit 401(k), 403(b), and SIMPLE retirement plans to make matching contributions to workers as if their student loan payments were salary reduction contributions.

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