DON'T DO IT ! Americans are using their retirement accounts to pay their student loans ---that’s bad
Student debt repayments are not eligible reasons to withdraw from 401(k) plans penalty-free
Diligent young Americans are putting away money for retirement, just to take it out to pay for student loans, new research found.
Americans struggle paying for housing and education, among other necessities and goals, but student debt seems to be keeping them from saving — or derailing whatever they do stash away. Six out of 10 young investors said education was the first or second biggest roadblock to retirement saving, and the concern over this expense has jumped almost 20 percentage points in the last four years, according to an E-Trade ETFC, +0.79% survey of almost 1,000 self-directed investors with $10,000 in an online brokerage account.
Three out of five of these investors made an early withdrawal from their retirement account to pay for their education, though it wasn’t clear if they took an early distribution (which can incur penalties) or a loan. “Neither will help you out but a loan is better than a withdrawal because the funds are still invested,” said Mike Loewengart, vice president of investment strategy at E-Trade.
A 401(k) loan is essentially an account holder borrowing his or her own money. Loans from 401(k) accounts must be repaid in full within five years and include interest. Loans can amount to $50,000, or half of the vested account balance, whichever is less. (Vested account balances are only what investors have accrued and can walk away with, not whatever money is owed to them, such as a company match they may get should they stay another few years at their companies). Although loans are better than simply withdrawing assets, it still cuts off potential investment returns, since future contributions are going toward making the account whole and not building a nest egg, Loewengart said.
Student loans have become a financial drag for young Americans, whether they’re aiming to save for retirement or not. Student debt surpassed more than $1.5 trillion last year, with no end in sight to the rising costs of college and graduate degrees.
At the same time, the country is facing a potentially harrowing retirement crisis. A steady stream of studies indicate Americans are not saving enough for their futures, and many adults say they expect no relief in the coming years because of their insurmountable cost of living. Popular personal finance advice suggests spending less on small purchases, such as lattes or even “grooming,” but young adults see this more as shaming than encouraging.
Sometimes young investors think they have nowhere to turn other than their retirement accounts, if they even have a retirement account. One in four adults under 35 years old with a 401(k) made an early withdrawal, according to a Merrill Lynch and Age Wave study of 2,700 adults earlier this year. Credit card debt was the number one reason they did so. But early distributions — not loans — often come with penalties if done before 59 ½ years old. Account holders must pay a 10% withdrawal penalty, except in certain situations, such as after separating from an employer (for any reason) after age 55.
There are also exclusions called hardship withdrawals, which allow penalty-free distributions and include paying medical expenses or college tuition — but student loan repayments are not eligible.
Young investors may have to make tough decisions, like paring down on retirement account contributions while paying off credit card or other high-interest debt. When choosing between student loan repayments and putting money toward a 401(k), they may want to try to meet the company match (if they can) so that they get some or all of the “free money” available, Loewengart said.
REPORTER - MarketWatch
Alessandra Malito is a personal finance reporter based in New York. You can follow her on Twitter @malito_ali.