Using 401k to pay for medical school

[The Beyonder]

I am thinking about taking money out of my 401k to pay for medical school, does anyone have similar plans? Any pros or cons come to mind?

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[Pons Asinorum]

I am thinking about taking money out of my 401k to pay for medical school, does anyone have similar plans? Any pros or cons come to mind?

Do not do that. You have an easy source of low-interest loan money to fund medical school if you get nothing in grants/scholarship/need-based/etc. You will be punished, heavily, for dipping into the 401k. Save it for retirement, or an actual crisis that doesn't have an easy funding mechanism.

 

[The Beyonder]

Do not do that. You have an easy source of low-interest loan money to fund medical school if you get nothing in grants/scholarship/need-based/etc. You will be punished, heavily, for dipping into the 401k. Save it for retirement, or an actual crisis that doesn't have an easy funding mechanism.

I know this is common wisdom on SDN, but if you can avoid the early withdrawal penalty (http://www.irs.gov/publications/p970/ch09.html) and are taking out relatively small amounts (15% tax rate), does taking withdrawals from a retirement account make more sense? Particularly considering the 7% interest rate loans will accrue and the fact that student loans can never be discharged.

 

[DrBowtie]

Simple math:
15% tax (your quoted rate) plus loss of % growth > 6.8% interest.

 

[sindadel]

Doesn't sound wise. It seems like you pay tax on the distribution and then have to pay back with after tax dollars even if you manage to avoid penalty. If you really are considering doing so, I'd call the IRS and talk to them about it, They are surprisingly helpful when it's not desperate tax season.

 

[Gauss44]

Try www.bogleheads.org too, and/or a financial adviser. Or if you ask her, http://www.suzeorman.com/contact-us/ask-suze-a-financial-question/, she might answer it on TV for all of us. This question is more complicated than it seems.

Also see: http://www.finaid.org/educators/pj/earlydistribution.phtml and watch out for a shift in your tax bracket.

 

[mspeedwagon]

I used to work at Merrill Lynch giving financial advise to people back in the day (before my days at the Dana-Farber).

Trust me when I say, DON'T DO THIS. It'll be one of the biggest mistakes you can make financially. You'll be killed on penalties (regardless of income bracket). Now, if you have money in a Roth IRA, feel free to pull that out (only the principle). If you don't have money in a roth, and make under the limits, then start contributing to one rather than a 401k (or to both ideally) and then you can pull out the principle from the ROTH to pay for med school. Remember to ONLY contribute to a 401k to the level of your employer match. After that you are far better off in a ROTH (assuming you qualify).

Taking loans against a 401K is one of the stupidest financial moves you can make. While the interest rate is low, you have to repay them with a large penalty. Unpaid 401k loans are not seen as debt (rather as you boring your own money). They CANNOT be discharged in bankruptcy (along with student loan debt). Most people don't that end up filing for bankruptcy never thought they would, and hope you never have to, but think about the financial burden this combination adds if you find yourself there.

Your best bet is to take out all the federal loans you can. Then take a private loan. Make sure to get fixed rate loans (dependent on credit you should be able to get one between 4-7%)

There is one loophole to the above, you can roll your 401k into an IRA and then withdraw the money from there without penalty. There is some fine print (you'll have to pay taxes), and I'd recommend consulting with a financial adviser if you go down this route.

 

[Gauss44]

Now, if you have money in a Roth IRA, feel free to pull that out (only the principle). )

👍

With caveats. Roth IRA withdrawals are counted as income, which may need to be reported on next year's FAFSA. Financial aid office might or might not adjust that if you explain. Link above explains. Then consider loan forgiveness, if you could qualify for that. And consider the time value of compounding interest in a retirement account... Another nice read: http://www.bankrate.com/brm/news/529/20051024a1.asp

 

[slothster]

I'm planning on using 401k money to finance med school. If you roll over to IRA, there's no penalty. Yes, it's taxed but it'll be taxed regardless: either now or come retirement. It all comes down to whether the market will beat 6.8% (loan rate). While it might, I'd rather lose out on that point or two to avoid taking on the debt.

 

[The Beyonder]

I'm planning on using 401k money to finance med school. If you roll over to IRA, there's no penalty. Yes, it's taxed but it'll be taxed regardless: either now or come retirement. It all comes down to whether the market will beat 6.8% (loan rate). While it might, I'd rather lose out on that point or two to avoid taking on the debt.

Apologies for not being more specific, but this is what I was thinking about doing. 15% tax rate seems like a much better rate then I will be able to receive at any other point (no income during school). It seems to me that the compounding interest on a student loan will balance out the compounding growth rate on my investments.

 

[mspeedwagon]

Very different from your initial post. Do a conversation to a IRA (corrected) and then pull out what you can. 15% tax rate. And, you're good to go.

It's actually not a bad financial move.

Apologies for not being more specific, but this is what I was thinking about doing. 15% tax rate seems like a much better rate then I will be able to receive at any other point (no income during school). It seems to me that the compounding interest on a student loan will balance out the compounding growth rate on my investments.

 

[sstespri]

Good advice everyone. I'm bookmarking this.

 

[The Beyonder]

Very different from your initial post. Do a conversation to a ROTH and then pull out what you can. 15% tax rate. And, you're good to go.

It's actually not a bad financial move.

I don't think I can do that (without penalty). I know I can roll over my 401k into a IRA. I know that can can take money out of an IRA without penalty for school expenses. I know that I will have no income in med school and the 15% tax bracket tops out at about 36k. Just trying to see if anyone has any info that makes this a bad idea that I am not aware of.

 

[mspeedwagon]

I can't believe I wrote ROTH (I meant traditional). Sorry, it's 6 a.m. in California and my mind is a little slow. Convert to an IRA and pull out.

You are correct that you cannot take money out penalty free until 5 yrs after a ROTH conversion and if you did earlier it would be subject to penalties.

I think there is one more critical piece of info. How much are you looking at pulling out? I'd be more comfortable with this personally, if it's not a huge amount you are looking to pull out.

I don't think I can do that (without penalty). I know I can roll over my 401k into a IRA. I know that can can take money out of an IRA without penalty for school expenses. I know that I will have no income in med school and the 15% tax bracket tops out at about 36k. Just trying to see if anyone has any info that makes this a bad idea that I am not aware of.

 

[slothster]

I can't believe I wrote ROTH (I meant traditional). Sorry, it's 6 a.m. in California and my mind is a little slow. Convert to an IRA and pull out.

You are correct that you cannot take money out penalty free until 5 yrs after a ROTH conversion and if you did earlier it would be subject to penalties.

I think there is one more critical piece of info. How much are you looking at pulling out? I'd be more comfortable with this personally, if it's not a huge amount you are looking to pull out.

I've spent some time modeling this out (PM me if you'd like me to send you my crude model).

While my model incorporates many assumptions (perhaps some that are grossly inaccurate), if your retirement account is < ~$200K, it seems to generally be in the best interest to use retirement funds instead of taking on loans. Within 10 to 15 years, you'll be caught up in terms of retirement savings. Plus, you will save yourself from the risks associated with big debt.

Other things to keep in mind are the ‘Tuition and Fees Deduction’ or the ‘Lifetime Learning Credit’ (https://www.aamc.org/services/first/first_factsheets/112402/education_tax_incentives.html). With a deduction of up to $4K, you can offset some of the income taxes on the money you take out of the IRA.

 

[Gauss44]

I've spent some time modeling this out (PM me if you'd like me to send you my crude model).

While my model incorporates many assumptions (perhaps some that are grossly inaccurate), if your retirement account is < ~$200K, it seems to generally be in the best interest to use retirement funds instead of taking on loans. Within 10 to 15 years, you'll be caught up in terms of retirement savings. Plus, you will save yourself from the risks associated with big debt.

Other things to keep in mind are the &#8216;Tuition and Fees Deduction' or the &#8216;Lifetime Learning Credit' (https://www.aamc.org/services/first/first_factsheets/112402/education_tax_incentives.html). With a deduction of up to $4K, you can offset some of the income taxes on the money you take out of the IRA.

There also might be an option of taking out the loans in the first place, getting a tax advantage, then paying them off with retirement funds. (Or if you want to make things more complicated for some quick money, you can pay it off with a rewards card, then pay off the cards, etc.)

Again, this is more complicated than it seems, even without that last part in parenthesis. Read the finaid.org article I posted above, as an example. A good financial adviser would be able to put all these little details into an action plan, step by step. Suze Orman is sounding better all the time. As is www.bogleheads.org

 

[Gauss44]

It seems to me that the compounding interest on a student loan will balance out the compounding growth rate on my investments.

Check with an expert on that. A real certified expert.

 

[mspeedwagon]

I second this advice. You want someone current on the topic. Laws change all the time and it's hard to keep up. Your plan seems find to me to the best of my knowledge (I personally, saved 100k in liquid and plan to take the rest out in loans. I'm leaving my retirement amount in place, b/c there is always the compounding factor and given that you may still be better with a higher interest loan). But, a certified expert is definitely the way to go.

Check with an expert on that. A real certified expert.

 

[yossarian444]

I guess I disagree with the majority of people on here.

At the end of M3/beginning of M4 year in medical school, I took out about 7K from my (non-roth) 401K. Best decision ever. I needed that for interviewing and relocating money - it was either that or take out a private loan...which isn't all that easy anymore - banks aren't just giving away the "M4 loan/relocation loan" anymore.

(Yes, your M4 year of medical school you are expected to come up with anywhere from $500- $20,000 in cash depending on 1) how competitive the specialty is and how competitive your application is for that specialty, 2) if prelim/TY is required for that specialty, 3) where in the country you are interviewing).

Yeah, I had to pay 15% or whatever the penalty for early withdrawl was. However, my income was $0, so I didn't have to pay any income tax on the money - just the penalty fee. Had I waited and pulled the money out when I was 65 years old, sure, I would avoid the penalty fee, but I'd be hit a lot harder with income tax since I'll be in a higher tax bracket.

I'm losing out on 3%-8% of interest per year on that money, but that's less than the rate I would have gotten in an M4 private loan.

Ultimately, 7K doesn't make a bit of difference considering I'm now over 330K in debt. My point is just to give a different perspective and not to just blindly follow the traditional advice of "NEVER raid your 401K." Non-traditional doctors is a highly unusual career path with wild swings of financial situations in less than a decade's time. Financial advisors don't run into too many people following the (student==>career==>post-bac==>med school==>residency==>doctor) path in life and the bipolar financial situations associated with that life. Many "financial planner experts" really only know what their company tells them to know - many of them give terrible (but well-intentioned) advice (eg, "buy whole life insurance!"). Blindly following financial advisors is partly why doctors make terrible investments.

 

[Gauss44]

I guess I disagree with the majority of people on here.

At the end of M3/beginning of M4 year in medical school, I took out about 7K from my (non-roth) 401K. Best decision ever. I needed that for interviewing and relocating money - it was either that or take out a private loan...which isn't all that easy anymore - banks aren't just giving away the "M4 loan/relocation loan" anymore.

(Yes, your M4 year of medical school you are expected to come up with anywhere from $500- $20,000 in cash depending on 1) how competitive the specialty is and how competitive your application is for that specialty, 2) if prelim/TY is required for that specialty, 3) where in the country you are interviewing).

Yeah, I had to pay 15% or whatever the penalty for early withdrawl was. However, my income was $0, so I didn't have to pay any income tax on the money - just the penalty fee. Had I waited and pulled the money out when I was 65 years old, sure, I would avoid the penalty fee, but I'd be hit a lot harder with income tax since I'll be in a higher tax bracket.

I'm losing out on 3%-8% of interest per year on that money, but that's less than the rate I would have gotten in an M4 private loan.

Ultimately, 7K doesn't make a bit of difference considering I'm now over 330K in debt. My point is just to give a different perspective and not to just blindly follow the traditional advice of "NEVER raid your 401K." Non-traditional doctors is a highly unusual career path with wild swings of financial situations in less than a decade's time. Financial advisors don't run into too many people following the (student==>career==>post-bac==>med school==>residency==>doctor) path in life and the bipolar financial situations associated with that life. Many "financial planner experts" really only know what their company tells them to know - many of them give terrible (but well-intentioned) advice (eg, "buy whole life insurance!"). Blindly following financial advisors is partly why doctors make terrible investments.

1. If yossarian444 took out more than 7k s/he might have had to pay taxes. There is a cut off limit set by the IRS, if you take more money than that limit, you will have to pay taxes. If you have to pay taxes, how much retirement money you take out (plus other income, etc.) pretty much determines your tax bracket here: http://www.bankrate.com/finance/taxes/tax-brackets.aspx

2. If yossarian444 would have withdrawn an IRA account instead of a 401k, s/he might not have had to pay any penalty (depending on the amount). Rule may distinguish between IRAs and 401k's. (Hopefully s/he got the relocating tax benefit.)

3. I agree that it might have made more sense to pay with retirement funds than to take out a private student loan. There might or might not be other options (like a home equity loan, promotional 0% apr balance transfer check from a credit card, etc.) as well.

4. If this were 2009 (which it might not have been), you likely missed out on much more than 10% interest.

5. Never ever "blindly" follow anything or anyone. If a financial adviser gets a commission or is super new, find someone else. Most will give you a consultation before you hire. (If a financial adviser tells you to put a bunch of money in insurance, that's a red flag!)

 

[DrTroll]

I have also given some thoughts into this. Like earlier posts indicated, roll over 401k to IRA then you can withdraw for tuition without incurring the 10% penalty for education purpose.

When you file your tax returns, personal exemption and deduction together will make the first $10,000 tax free. The lifetime learning credit ($2,000) can make your next $16,000 withdrawal tax free (using the IRS tax table to match with $2,000 tax).

So if my assumptions are right, you should be able to withdrawal $26,000 each year tax free if you are single.

On top of that, any withdrawal from $26,000 to $45,000 should be in the 15% bracket. (I got the $45,000 number using exemption and deduction $10,000 plus 15% bracket $35,000).

If there's anything I'm mistaken, please correct me. But given that the loans make available to us at 6.8% to 7.9% without a chance to refinance at a lower rate, using retirement savings may just be the better deal.

 

[wookiewookie]

This is correct and IMO, a good idea.

I just spoke with my 401k broker and confirmed that transferring from 401k to traditional IRA allows for the 10% penalty exemption, but the funds are of course then considered taxable income when tax time comes around.

If you are in the 15% tax bracket or do run into problems and have to pay tax on the withdrawn funds, would it be advisable to wait until 2nd year medical school when you are fully unemployed and would have been for the prior year, so your taxable income would be at its lowest?

 

[slothster]

...would it be advisable to wait until 2nd year medical school when you are fully unemployed and would have been for the prior year, so your taxable income would be at its lowest?

Yes, since it will likely put you into a lower bracket (depending on how much you earned during 1st year). But, this assumes you have other liquid savings to pay for 1st year. If not, it still might be in your best interest to use retirement account money and avoid student loans, especially considering the tax credit (see my above post).

 

[The Beyonder]

This is correct and IMO, a good idea.

I just spoke with my 401k broker and confirmed that transferring from 401k to traditional IRA allows for the 10% penalty exemption, but the funds are of course then considered taxable income when tax time comes around.

If you are in the 15% tax bracket or do run into problems and have to pay tax on the withdrawn funds, would it be advisable to wait until 2nd year medical school when you are fully unemployed and would have been for the prior year, so your taxable income would be at its lowest?

I plan on waiting till 2014. I figure after the new year one would start at zero taxable income and it would be safe to start withdrawals.

 

[Guero]

Or perhaps wait until 4th year to withdraw it for relocation and interview expenses, all the while letting your original sum grow another four years before withdrawing.

I have a 403b with >$16k with a consistent 15-25% annual rate of return, even during the downturn. Initially, I was dead-set on leaving it in there in case something went wrong before my financial situation turned into "attending salary without school loan debt." But after reading this, I think I'm going to try to find a certified, independent professional for some advice... I can see it going both ways... You've all made great points for and against this issue... But no current physicians...

 

[The Beyonder]

Hey all, I spoke with a financial planner and a representative from fidelity about paying for school with money for an IRA. The relevant section of the tax code is in IRS publication 590.

Higher education expenses. Even if you are under age 59, if you paid expenses for higher education during the year, part (or all) of any distribution may not be subject to the 10% additional tax. The part not subject to the tax is generally the amount that is not more than the qualified higher education expenses (defined later) for the year for education furnished at an eligible educational institution (defined later). The education must be for you, your spouse, or the children or grandchildren of you or your spouse.
When determining the amount of the distribution that is not subject to the 10% additional tax, include qualified higher education expenses paid with any of the following funds.
Payment for services, such as wages.
A loan.
A gift.
An inheritance given to either the student or the individual making the withdrawal.
A withdrawal from personal savings (including savings from a qualified tuition program).
Do not include expenses paid with any of the following funds.
Tax-free distributions from a Coverdell education savings account.
Tax-free part of scholarships and fellowships.
Pell grants.
Employer-provided educational assistance.
Veterans' educational assistance.
Any other tax-free payment (other than a gift or inheritance) received as educational assistance.
Qualified higher education expenses. Qualified higher education expenses are tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a student at an eligible educational institution. They also include expenses for special needs services incurred by or for special needs students in connection with their enrollment or attendance. In addition, if the individual is at least a half-time student, room and board are qualified higher education expenses.

Taking money out of an IRA while in medical school can be a good way of avoiding taxes. While in medical school you will have zero taxable income and a lifetime learning credit. Use this tax calculator (http://apps.irs.gov/app/withholdingcalculator/) to see where you would be at, but my numbers were surprisingly low. You can still invest your money, but you will be free to invest that money in anyway you choose.