The idea of using 401(k) or IRA savings to reduce immediate student debt burdens can be appealing, considering retirement seems distant while student loans demand immediate attention.

However, this strategy often leads to more financial woes than relief. While there are rare instances where such a move could be beneficial, most borrowers find an alternative approach to be preferable.

Can retirement funds from a 401(k) or IRA be used to pay off student loans?

If you have money in retirement accounts, no law prevents you from using your money to pay off your student loans.

However, just because you can make this move doesn’t mean you should.

There are three major issues with taking money out of a retirement account to knock out student debt:

• Income Taxes on Withdrawals: Withdrawing from a 401(k) or traditional IRA incurs income taxes, as these funds are tax-deferred.
• Early Withdrawal Penalties: If you’re under 59.5 years old, early withdrawals typically trigger a 10% penalty.
• Reduced Retirement Savings: Using these funds for student loans decreases your retirement savings, potentially leading to financial challenges later in life.

Early withdrawal penalty exceptions

There are several circumstances where an IRA or 401(k) early withdrawal penalty can be avoided. These exceptions include buying a first home, medical expenses, and Covid-19.

Educational expenses are also included, but this exemption doesn’t extend to student loan payments. Therefore, using retirement funds for a child or grandchild’s education is penalty-free, but the same rule doesn’t apply to paying off your own student loans.

It’s important to note that even in cases where penalty-free withdrawal is possible, it might not always be the wisest financial move if there are better alternatives.

Alternative Options

Rather than tapping into retirement funds, consider these alternatives:

Refinance Student Debt: If you have enough money in your retirement account to eliminate your student loans, the odds are pretty good that you could find a lower interest rate through student loan refinancing. One lender, Earnest, even considers retirement accounts when making lending decisions. Several lenders currently offer refinance rates around 5%. If the interest rates on your student debt are lower than what your retirement account is earning, you will come out way ahead.

401(k) Loans: A 401(k) loan, where you borrow from your fund and repay it, could be an option, avoiding taxes and penalties. However, failure to repay means taxes and a 10% penalty.

Reduce Retirement Contributions: Lower your contributions to your retirement fund to free up funds for paying off high-interest student loans, especially if you’re not benefiting from employer matching.

These strategies provide different approaches to managing student debt without compromising retirement savings.

When it makes sense to use retirement accounts for a student loan payoff

There are a few circumstances where dipping into retirement accounts is a reasonable choice.

• If you have already reached age 59.5 – If you are old enough to make a penalty-free withdrawal and you feel confident about your finances heading into retirement, pulling the money out to pay down student debt makes sense.
• If you have money in a Roth IRA – Roth IRAs are treated differently than traditional IRAs. Savers can withdraw Roth contributions at any time without penalty. Roth accounts only charge a penalty if earnings are withdrawn before age 59.5. Moving money out of a Roth account makes sense for borrowers who have high-interest student loans. If your student debt is charging 13%, but you only expect to earn 7-10% on your Roth account, moving the money is a logical choice.

The Big Concern with 401(k) and IRA Withdrawals

Raiding your retirement accounts may provide temporary relief from present difficulties but can lead to severe future challenges.

Consider this scenario: you decide to forgo student loan payments for the next three months. In the short term, it provides some relief. However, in the long run, your loan balance grows, accompanied by late fees, ultimately worsening your overall financial situation. Similarly, prematurely tapping into your retirement account is a short-sighted move.

Managing student loans can be demanding, but facing an underfunded retirement later in life presents even greater challenges. When you can no longer work and struggle to meet your financial obligations, the difficulties multiply.

The post Should I Empty My Retirement Accounts to Pay Off My Student Loans? appeared first on The Student Loan Sherpa.

For borrowers on income-driven repayment plans, monthly payments are calculated based on what a borrower can afford to pay. Putting money in certain retirement accounts essentially shields that income from being included in monthly payment calculations.

It might sound like a bit of accounting voodoo, but getting lower payments via retirement contributions is pretty simple.

Why Putting Money in a 401(k) or 457 Retirement Plan Means Lower Student Loan Payments

The whole “process” is basically three steps:

1. Put money in an eligible retirement account.
2. Claim a tax deduction for the retirement contribution.
3. Get a lower student loan payment on an IDR plan.

Step three is the one with the potential for confusion. To make sense of it, borrowers need to understand how monthly payments on Income-Driven Repayment (IDR) plans work.

The appeal of an IDR plan is that borrowers can make payments based on what they can afford to pay. The Department of Education calculates a borrower’s “discretionary income” in order to determine what they can afford to pay.

The starting point for the dictionary income calculation is usually the borrower’s Adjusted Gross Income (AGI) from their most recent tax return. The larger your AGI, the more you will be expected to pay on an IDR plan.

Shifting back to the retirement side of the equation, some retirement contributions qualify for a tax deduction. This tax deduction lowers the taxpayer’s AGI. The reduced AGI essentially shelters income from student loan payment calculations.

In other words, putting money in a retirement account lowers your income for tax purposes. This “lowered income” means lower payments on income-driven repayment plans.

If things are still a bit fuzzy, the next section will cover the eligible retirement accounts, and later on we will do a quick example with actual numbers.

The Exception: Roth 401(k)s and “Post-Tax” Accounts

Sadly, not all retirement account contributions mean lower student loan payments.

Some retirement accounts are considered “pre-tax” because the money placed in the retirement account isn’t taxed yet. These accounts are also commonly called tax-deferred, meaning you don’t pay taxes until the money comes out of the account.

These contributions that lower your tax bill are the ones that lower student loan payments. Common examples include most 401(k)s, 457 plans, and IRAs.

Borrowers don’t get a student loan benefit if the retirement account is a “post-tax” account. Post-tax contributions don’t lower your tax bill, which means they don’t help with student loan payments. Common examples of post-tax retirement accounts are Roth IRAs and Roth 401(k)s.

Sherpa Tip: If you get a tax deduction for putting money in your retirement account, it also means lower payments on income-driven repayment plans.

Other Ways to Save for Retirement and Lower Student Loan Payments

Clever borrowers might also wonder if other tax breaks mean lower student loan payments.

The answer is yes. Several other tax deductions also mean lower student loan payments.

However, not all tax deductions mean lower student loan payments. The critical detail on tax deductions is whether or not the deduction lowers your AGI. Tax pros call deductions that lower AGI “above-the-line” deductions. The tax breaks that don’t lower AGI are “below-the-line” deductions.

The following deductions are “above-the-line” and will lower income-driven student loan payments:

• Health Savings Account Contributions
• Alimony Payments
• One-half of Self-Employment Taxes
• Student Loan Interest

Deductions that do not lower student loan payments include the following:

• Charitable Contributions
• Mortgage Interest
• State and Local Taxes

Taking Advantage of Lower Payments for Tax Breaks

Before getting too excited about the opportunities for lower student loan payments, it is worth remembering that debt elimination is the goal of all borrowers. Lower monthly payments are nice, but they also mean spending more on interest in the long run.

The people chasing after student loan forgiveness will benefit the most from using retirement contributions to lower payments. If you are on your way to Public Service Loan Forgiveness, putting money in the correct retirement account means lower monthly payments, a reduced tax bill, more money saved for retirement, and more student debt forgiven.

Even if forgiveness isn’t on the horizon, the lower payment is still helpful. If you have a reduced federal student loan bill, it means you can focus your efforts on attacking your high-interest private loans or saving for a home down payment.

An Example with Actual Numbers

Suppose I make $60,000 per year working for the government.

I have a lot of federal student debt, so I enroll in an income-driven repayment plan. If I choose the SAVE plan, my monthly payments will be $226 per month, according to the SAVE Payment Calculator.

I realize that I need to be saving more for retirement, so I have my employer start withholding $200 per paycheck for my retirement. Taxes vary from state to state, but for this discussion, let’s assume my $200 contribution per paycheck lowers my take-home pay by $150. After a full year, I will have set aside $5,200 for my retirement.

That retirement contribution lowers my AGI by $5,200. According to the loan simulator, the lower AGI reduces my monthly payment to $183 per month. If I’m working for an employer eligible for PSLF, the lower payments would mean more debt forgiven after ten years.

In the months I receive two paychecks, I will have set aside $400 for retirement, spent $43 less on my student loans, and only lost out on approximately $300 worth of take-home pay.

To recap, by setting aside money for retirement, I’ve accomplished the following:

• Lowered my monthly student loan payment,
• Increased the money set aside for my future,
• Lowered my tax bill, and
• Increased the amount of debt that can be forgiven.

Long-Term Benefits: This approach has significant long-term benefits. The $200 set aside each paycheck can reasonably be expected to grow as time passes. Your original contributions may have grown considerably by the time you reach retirement age, depending upon your investment strategy. A hidden advantage to this approach is that borrowers get an early start on interest working for them instead of against them.

Clearly, some sacrifice is required to utilize the connection between retirement, payments, and forgiveness. However, for the borrowers who can forgo a bit of income today, the future benefits are pretty significant.

Why this is my Favorite Student Loan Hack?

For many student loan borrowers, retirement is a problem for the future. Student loans are the crisis of the present.

Taking advantage of this hack requires setting money aside for retirement. I love the idea of saving for the future and making the present a little bit easier.

The post How 401(k) and 457 Retirement Plan Contributions Lower Student Loan Payments appeared first on The Student Loan Sherpa.

Many federal borrowers depend upon income-driven repayment plans like IBR, PAYE, or SAVE to keep their monthly payments affordable. On IDR plans, payments are based on what borrowers can afford rather than what they owe.

The way the government calculates what a borrower can afford has some strange consequences for those saving for retirement.

Some retirement maneuvering can actually result in lower student loans and more student debt forgiveness. Other retirement planning strategies may cause larger student loan payments, even though the borrower moves money from one retirement account to another.

Today, I’ll break down how the government calculates monthly payments and how your retirement planning can influence monthly payments.

Defining Income for Income-Driven Repayment Plans

The critical number for borrowers to watch is their Adjusted Gross Income (AGI) from their most recent tax return. As AGI goes up or down, monthly student loan payments go up or down.

AGI is an all-important number because it is the starting point for discretionary income calculations. The Department of Education calculates discretionary income and then charges borrowers a percent of that number each month. The higher your AGI, the higher your discretionary income, and the higher your monthly payments.

As borrowers, we have a huge incentive to keep our AGI as low as possible during tax season. A lower AGI means a lower tax bill and lower student loan payments.

Retirement plan contributions, conversions, and withdrawals can have a huge impact on AGI.

Roth Conversions

In a Roth conversion, a taxpayer moves money from a retirement account like a 401(k) or traditional IRA and puts it in a Roth IRA. There are many circumstances where a Roth conversion is a sound retirement planning strategy.

However, the downside to a Roth conversion is that Uncle Sam charges taxes on the money that moves into the Roth account. The year you transfer money from a traditional IRA or 401(k) into a Roth account, it will raise your AGI.

In other words, a Roth conversion can mean larger student loan payments.

From the borrower’s perspective, this seems unfair. Moving money from one retirement account to another doesn’t mean you have extra money to pay toward your student loans. Unfortunately, the discretionary income calculation is a blunt instrument, and anything that raises your AGI raises your student loan payment.

Sherpa Tip: A Roth conversion isn’t always a bad idea if you have federal student loans. However, you should consider the increased monthly payment as one of the potential downsides of the conversion.

401(k) and IRA Rollovers

Moving money from a 401(k) into an IRA is a common retirement planning move. If you change employers, moving the money from an old 401(k) account is often a really smart move.

For student loan borrowers, a traditional IRA rollover is harmless.

When the money goes from the 401(k) of your old workplace into your traditional IRA, there are no tax consequences. No tax consequences mean no changes to your AGI and no impact on your monthly student loan payments.

What is the difference between an IRA Rollover and a Roth Conversion?

Traditional IRAs and 401(k) are tax-deferred accounts, meaning the money goes into the account without paying income tax. You don’t have to pay taxes until it comes out.

In a Roth account, you pay taxes on the money before it goes in, but withdrawals during retirement are tax-free.

Thus, if you move money from one tax-deferred account to another, there is no tax bill, but if you move from a tax-deferred account to a Roth account, you have to pay taxes on the money that moves.

401(k) and IRA Withdrawals

Pulling money out of a 401(k) or traditional IRA before retirement is expensive. In addition to the regular taxes that apply, a 10% early withdrawal penalty may also apply.

Because of the high cost associated with an early withdrawal, this move typically only happens when someone is facing a major financial emergency, makes a mistake, or qualifies for a penalty-free withdrawal.

Regardless of the circumstances that lead to the withdrawal, it is bad news for student loan borrowers. Money that comes out of a 401(k) or traditional IRA increases your AGI. Thus, whether you are retired or in a financial crisis, withdrawals can increase student loan payments.

Retirement Contributions

The flipside of this equation is retirement plan contributions.

If you put money in a tax-deferred account like a 401(k) or traditional IRA, it lowers your tax liability. These contributions lower your AGI and lower student loan payments for borrowers on IDR repayment plans.

Not everyone can afford to make retirement contributions, but if you can swing it, the advantages are huge. Setting aside money for retirement means:

• a lower tax bill
• lower IDR payments for a year
• more debt is forgiven if you reach forgiveness

This strategy is my favorite way to eliminate student debt and save for retirement.

Final Thoughts on Roth IRA Conversions, 401(k) Withdrawals, and IRA Conversions

Up to this point, we have only looked at the student loan consequences of these moves.

A Roth IRA conversion isn’t always a bad idea for student loan borrowers. Similarly, your finances may necessitate an early withdrawal from a 401(k).

The planning behind any retirement account maneuvering should go far beyond the student loan impact. However, the student loan consequences should undoubtedly factor into your decision.

The post How Roth IRA Conversions, 401(k) Withdrawals and Other Retirement Moves Affect Student Loan Payments appeared first on The Student Loan Sherpa.

Each borrower has different financial circumstances, and some variables are impossible to know. Employment circumstances may change. The stock market may do really well, very poorly, or somewhere in between.

Fortunately, there are times when the decision is easy. Even when the decision isn’t obvious, most borrowers can find an efficient strategy by asking the right questions.

When You Should Definitely Put Money in a 401(k)

Some employers have excellent 401(k) plans. Specifically, they match employee contributions. These employers will even match, dollar for dollar, employee contributions. That means for each dollar you save, your employer will add a dollar to the account.

Less generous employer matching programs can still be a great deal for student loan borrowers.

Suppose your company will contribute 50 cents for every dollar you save. You are essentially getting a 50% return on your investment from day one. That is hard to beat.

When the Choice to Pay Down Your Student Loans is Obvious

Other people don’t have employers that match employee contributions. These people may have student loan interest rates well over 10%.

If you have an outrageous student loan interest rate, putting out that fire should be a priority.

It doesn’t make much sense to make an investment that you expect to earn 7% if your student loan charges 14%. Giving away a dime to make a nickel is a lousy strategy.

Adding Student Loan Forgiveness to the Equation

Many borrowers have federal student loans that may be eligible for some form of forgiveness.

For the borrowers chasing after forgiveness, putting money in the 401(k) becomes more appealing.

If the debt is on track to be forgiven, paying extra doesn’t make much sense. It just means less debt can be forgiven.

401(k) contributions provide additional benefits to the borrowers chasing forgiveness. By putting money in a 401(k), you lower your tax bill. The reduced tax bill means lower student loan payments. Lower student loan payments mean more money gets forgiven. Putting money in a retirement account to save money on student loans is one of my favorite student loan hacks.

Dealing with a Close Call

Unfortunately, the answer won’t always be obvious.

I like to think of student loan payments as an investment with a guaranteed return. If I pay an extra $100 on a student loan charging 7% interest, that $100 is earning a guaranteed return of 7%.

Many investments hope to earn 7% or better, but there isn’t an option out there that generates such a high guaranteed return.

Borrowers have to decide their willingness to accept risk. You have to weigh the fixed return on an extra student loan payment against the potential upside of investment growth.

A Note on Taxes: 401(k) contributions normally result in a lower tax bill. Additionally, student loan interest is a tax deduction. These tax factors may shift the scales enough to make putting money in a 401(k) the better decision. This is a good subject of discussion to have with your tax preparer at tax time.

Student Loan Refinance and Shifting the Numbers

One way to make a difficult decision easy is to refinance your student loans.

Suppose you decide 6.8% is the cutoff point for you. If your student loans are above that number, they get paid off first. Student loans below that interest rate take a backseat to 401(k) contributions.

Borrowers can refinance their student loans at a lower interest rate to free up money each month to save for retirement.

Presently, student loan interest rates in the 20-year, fixed-rate category are extremely low. Borrowers can lock in a low rate on their student loans and focus their efforts on building up their retirement savings. The catch is the borrowers need a decent credit score to qualify.

Rank	Lender	Lowest Rate	Sherpa Review
1		6.08%*	Splash Financial Review
2		6.53%	ELFI Review
3		6.55%	Laurel Road Review

The post Should I Put Money in a 401(k) or Pay Down My Student Loans? appeared first on The Student Loan Sherpa.