Should I pull $ from my 401k to pay student loans?

November 15, 2020 9:33 AM

Partially motivated by fears about the stock market but also partially not. See inside for details.

I currently have a high paying job (probably the high mark of what I will ever earn unless I stay in this job longer) that makes me miserable and also have a lot of student loans, and feel I should stay in my current job until loans are paid off.

I have about $110,000 in my 401k and $144,000 in student debt. The interest rate on the student debt is between 4-6% for different loans. Expecting a return of about 4% from my 401k, and with the CARES act which eliminates the 10% penalty, I think I could pull up to $100k and make a huge dent in my student loans, then stay in my current job for another year or so until they’re completely paid off.

This is partially motivated by fear that the market is going to tank due to all the bullshit currently going on and my 401k savings will evaporate while I still have a ton of loans. But even if I weren’t worrying about the market, doesn’t it make sense to pay off the student loans which have a crappy high interest rate anyway? I can’t know the future of market behavior, obviously, but at this point if I got laid off AND there was a crash I would just be so thoroughly fucked with my insanely high student loan balance.

I’m 30. I will continue to contribute pretax to my 401k. I’m kind of financially illiterate and only in the past few years have established this 401k fund because of the job I have now. I think even if I stay in my job I’ll feel better about not having the student debt albatross.

I know how people say don’t panic etc. about the market but I was starting to think even if there was no reason to expect a downturn, with the CARES act this would be a good idea anyway. Can anyone tell me what I’m overlooking?

posted by anonymous to Work & Money (16 answers total)

I have no idea how this works because I live in Canada, but one thing I would check is whether you have to pay income tax on the money you withdraw from your 401k.
posted by heatherlogan at 9:42 AM on November 15, 2020

Do not try to time the market, especially if you are "kind of financially illiterate." What you're overlooking is that time is on your side as a 30-year old with compounding interest and that much money in your 401k, even if the market tanks soon.

We don't have enough information about your student loans (are they federal loans? have you consolidated them?) to provide concrete advice, but this kind of discussion comes up all the time over on r/personalfinance and r/studentloans.

Assuming all goes well with the Biden administration, there is a very real chance of student loan reform. Several months ago I was thinking about trying to pay the remainder of my student loans off by the end of the year while the interest rates are temporarily waived. I've throttled back on that because I'm waiting to see if some of the plans actually go into effect.
posted by mostly vowels at 9:44 AM on November 15, 2020 [16 favorites]

Aside from any early withdrawal penalties or vesting limitations, what you’re overlooking is that you can’t take out loans to pay for retirement. Funded retirement + student loans is better than no retirement + no student loans.

The interest rate on the loans is also only about half of the expected/estimated return on your 401k investment (over the long term). If the interest rate on debt is less than the return on investment, it’s more financially beneficial to keep the debt and the investment.

I understand the desire to pay down debt, and if you want to go for an aggressive repayment plan, have at it. But don’t sacrifice retirement investments or essential liquidity to do that. Your low interest rate student loan debts are not an emergency, even though they feel like a burden.
posted by rue72 at 9:45 AM on November 15, 2020 [31 favorites]

I would do as much of the opposite as possible of your request. Right now the market is a little under equilibrium, and I'd expect huge growth as things recover. I would pay as little as possible and maximize your 401K as much as possible. Any spare change, dump into your 401K before the end of the year.

Also, make sure your 401K is in an S&P 500 low cost fund to maximize your gains, not a mixed portfolio with "lower risk" stuff. You have a long time for risk to balance itself out.
posted by bbqturtle at 9:48 AM on November 15, 2020 [8 favorites]

There's a possibility the new administration will be addressing student loans in the next year or two. Perhaps wait until there's some clarity there as well?
posted by JoeZydeco at 10:19 AM on November 15, 2020 [4 favorites]

I know that student debt feels overwhelming, but it is fantastic to have that much in your 401K at age 30. Even if the stock market tanks, you still have more than 30 years for it to recover. Your retirement isn't for the short term. I know you know this, but the best way to invest at such a young age is what you are doing, with one exception: don't pay attention to the balance. Like, it's okay if you don't even know what the balance is on a day to day basis. I don't think there's any reason to. The market will always fluctuate, and the most successful long term investment strategy in a 401K is to ride it out. Now, if you were 55, the advice might be different. But you have many years to go.

But, in an even more practical sense: there's a chance that Biden might do at least some student debit cancellation. It probably won't be total cancellation, but I think the worst time to pay down student debit is right now. What if they waive a percentage? You benefit from your balance being higher. Here's what the NY Times is saying about the possibilities with a Biden administration, and there are lots of variations here, including lower payments based on income (which means that you would have low payments if you lost your job).

So you asked what you are missing. I think what you are missing is that you are experiencing a lot of anxiety about this debt and your work situation, and you lack the understanding of debt and income and investing to make a sensible decision. Given that you have a high paying job, I wonder if your employer has an Employee Assistance Program (EAP) or something similar (this would be through HR) where you can get short term counseling on a range of subjects, often including debt and financial management. I think you would benefit from a conversation with a trusted, experienced professional who isn't in a position to sell you anything or make money from any financial decisions you make. I think you would benefit from some financial counseling and perhaps some financial or personal therapy to talk about anxiety and stress around work and finances and money.

I get that this debt is an albatross, but I don't think your priority should necessarily be paying down your student debt so aggressively. I think you have conflated your debt with your feelings about your job, and you feel like you can't leave your job til you pay off your debt, so therefore you want to pay off your debt as quickly as possibly to give yourself permission to leave your job. You may very well be able to get another job that doesn't make you miserable and still manage the debt. A financial planner or counselor can help you with this, and you may very well have access to these resources for free. Or, you can use some of your income to pay for this.

I also think you might benefit to listening to some financial planning podcasts. There's So Money with Farnoosh Tobari. Oh My Dollar is specifically aimed at millennials and folks just figuring this stuff out, without shame.

All of this to say: what you proposing might seem right, but you are missing the big picture here. Please talk to some professionals before you do something like this.
posted by bluedaisy at 10:32 AM on November 15, 2020 [10 favorites]

I would look for every area in my life other than retirement savings to try to find money to aggressively pay down the student loans. If you have a long time to let the 401k grow (as it sounds), short term crashes etc are not important. A dollar invested in the S&P 500 20 years ago would be worth about 2.5 dollars today, and that is after several serious crashes (early 2000s, 2008, March 2020). It's a bumpy ride but over the very long term the market generally goes up.

Further, it is very important to "pay yourself first" in the way you allocate savings/spending/etc. If you don't prioritize saving for yourself (paying yourself), it is very easy to let everything else eat up your income (bills, debt, etc.). By paying yourself first, you force some discipline into your other spending. If you pay yourself last (i.e., shortchange savings to pay other things), you'll find that there isn't any money left over for long term savings. The 401k contributions you have been making are a form of paying yourself first.

You will also have to pay income tax on the withdrawal, so you will "lose" a hefty chunk of the 100k you pull out to income tax, whereas if you stayed invested you would have the benefit of the full 100k compounding in the market. I haven't run the calculators, but I would expect that the income tax hit will more than outweigh the different expected interest rates/rate of returns you are using. (I.e., it's not as simple as trading a 4% return for a 6% interest cost, because the dollars you pull from the 4% return are going to get knocked down ~30%).

I know the debt amount seems horribly high and scary to you as a young person, but if you think about repaying that amount over a chunk of your working life (e.g., 10 or 15 years), it isn't a nightmare amount.
posted by Mid at 10:35 AM on November 15, 2020 [2 favorites]

I’m about your age, have more student loan debt than that, and almost certainly make less than you do (I wish I had that kind of 401k balance!). What kind of student loan debt do you have? If you have federal loans, my approach has been to sign up for whatever income based repayment plan makes my payments the lowest and just plan on treating my loan payments as a tax on my education for the 15-20 years until my repayment plan is over (and planning for the hit on my income taxes that forgiveness will cause), or until some Democratic administration reforms the system. If my income is high enough at some point in the future that I can actually pay them off, great! That’s not where I’m at right now. I prioritize every form of saving and avoiding consumer debt over throwing money into the bottomless abyss of my student loans. My credit score is great.

Your situation may be different, but I guess my point is why do you feel this loan is an albatross? I don’t think the federal government, if you have federal loans, or whatever banks holds your private loans, is so hurting for your money that you should bankrupt your retirement fund to pay them. Just treat the payments as another unavoidable monthly bill, sit on that fantastic 401k balance and let it grow over time, and go find a job you like better.
posted by MadamM at 11:17 AM on November 15, 2020 [1 favorite]

feel I should stay in my current job until loans are paid off.

This clause suggests to me the following reasoning. Try this on to see if it matches your thinking:

- I hate this job and I want to leave it.
- But my student debt is so high and the job pays well.
- I'll tough it out until I can pay off my loans.
- But I HATE this job and I want to leave it.
- Lightbulb! I'll raid my 401k to pay the loans! That way I can follow the rule I made for myself and still escape from this hellhole.

If this is where you are, I am now your fairy godmother. I officially grant you permission to leave this job before your loans are paid off.

I officially do not grant you permission to raid your 401k, fairy godmothers don't go for self-destructive stuff like that.
posted by medusa at 11:52 AM on November 15, 2020 [13 favorites]

> I currently have a high paying job (probably the high mark of what I will ever earn unless I stay in this job longer) that makes me miserable

It's worth trying to fix this situation so you find a place where you can continue to contribute savings towards paying off loans & building assets for retirement, but in a way that's more emotionally/mentally sustainable. There are lots of jobs out there, there's a fair chance there's a few options that would pay better and might not make you miserable, or at least pay no worse.

Another sounding board for advice about personal finance are the bogleheads.org forums -- they're mainly focused around low-cost, simple investment plans for retirement, but there's often also discussion about loans, managing debt, etc. e.g. here's a few threads similar questions to yours:

1. 401k withdrawal to pay (or accelerate) student loan payoff?
2. Student Loan REFI -- pre COVID/CARES act, but suggests another option could be to refinance the student loans at a lower rate.

I'd encourage you to get a check up on your retirement plan and ask for advice about your situation on the Bogleheads forums -- giving more information about your student loans -- how much debt is at a 4% rate? how much debt is at a 6% rate? Are the loans federal loans or private loans? -- and also providing more details about how your investments in the 401k portfolio are allocated. The Bogleheads forums require information to be provided in a standardised way so the other forum members who review your situation can easily tell what's going on and hence give more useful and appropriate advice.

All that said, I think your expectations of a 4% return on the 401k -- say a 4% _real_ return after subtracting 2% inflation -- may be more realistic than some of the more enthusiastic beliefs about future stock market returns expressed upthread. Since US bonds are yielding negligible returns and US stocks are priced relatively dearly compared to the forecast economic performance of the underlying businesses, it is highly unlikely a portfolio of US stocks + US bonds will be able to produce long term returns similar to what was achieved historically over the last few decades under different conditions. If I had to make a forecast for long term real returns for the tech heavy NASDAQ 100 index I might expect around a 0.5% real return --using a crude CAPE-based forecast (this is after a +35% gain of the NASDAQ 100 index this year to date)
posted by are-coral-made at 12:02 PM on November 15, 2020 [1 favorite]

I did this in 2007 when I was 35. Although I didn't predict the 2008 crash. I was just at a point of stability in my life, and had a little more in my 401k as I had in student loans. The other thing that pushed me to pull the trigger was that I had defaulted on my student loans a few years before, and had accrued a bunch of penalties. I called my loan company (I had consolidated), and they were willing to knock all the penalties off which was about 20% of what I owed if I made a lump sum payment. I also talked to my 401k company who walked me through all the details and helped my make sure I covered my tax liability (and I did avoid the early withdrawal penalty). It felt great to have those loans off my back.

I was able to immediately put the amount I would have been paying monthly on the loans back into my 401k. And then I was totally blessed by the fact I sold high, and was more aggressively contributing to my 401k when the market was low, and then in a steady climb. I rebuilt my 401k to the same level in about 2 years if I recall correctly. Most of my situation was dumb luck... but it was the best financial decision I ever made.
posted by kimdog at 12:30 PM on November 15, 2020 [6 favorites]

You shouldn't raid your retirement fund, because doing so will deprive you of the opportunity to accumulate compound interest. There is plenty of time for the stock market to recover before you hit retirement. Moreover, borrowing money isn't a retirement plan. Finally, consistently paying down your student loans will increase your credit score, but perhaps counter intuitively paying off your student loans may hurt your credit score in the short run because it will remove long term accounts from the calculation.

Agree that you should check out bogleheads forums / books. They will give you a good overview on best practices. If you do decide you still want to meet with a financial advisor, be sure to choose a fiduciary one.

Some student loan providers give a small interest rate deduction for setting up autopay.

The other financial piece that you should save for if you haven't already is a six month emergency fund. Do this before paying extra on your student loans.

I concur that the Biden administration will do something with students. If can hang tight for a few months, you might have more options than you do now.
posted by oceano at 2:18 PM on November 15, 2020

I think the income tax hit is what you have to consider, not the penalty. If you can't repay your withdrawal in 3 years you have to plan to pay income tax on what you cant repay. Then you end up owing the irs instead of your student loan creditors.

Are your loans private or federal or a mix?
I'd pay down the high interest loans first, but only withdraw as much as you think you can repay to your 401k in 3 years.

Also,if you are financially illiterate get an accountant to do your taxes for the next few years
posted by jello at 4:05 PM on November 15, 2020

Now is really not the time to do this because I think chances are good that the Biden/Harris administration is going to make student loan forgiveness a priority. One proposal I've seen would eliminate up to $50,000 per borrower. I have followed the student loan and forgiveness policy debates over the last few years and I think we're the closest we've ever been to it actually happening. That's not a guarantee, but I would so much rather you keep that $50,000 in your 401k than give it to a lender only for debt to be forgiven in 1 - 2 years.

Plus, aside from the fact that student loans aren't dischargable in bankruptcy, student debt is some of the most flexible and low-interest debt out there, particularly if you can consolidate with the federal government. I know that debt may feel burdensome, but you are most likely going to be better off financially if you prioritize investing/maintaining funds in your retirement accounts over paying down student debt. Additionally making regular payments on your student loans is good for your credit -- in fact, it's even better for your credit than paying off your debt all at once and closing the account.

The exception in terms of raiding your retirement account would be if you can do what kimdog did and pay it back right away, but if that would mean staying years in a job that's detrimental to your health, then I think it's probably better to just let the student loans ride or explore alternative strategies. For example, if you federally consolidate you can apply for an income-based repayment plan so that you're not tethered to really high payments and having to make job decisions based on your loans.
posted by Colonel_Chappy at 7:01 PM on November 15, 2020

Since you mention having a high paying job, note that you may not actually be eligible for the CARES penalty-free 401k withdrawal. You only qualify if you, your spouse, or a dependent contracted COVID or if your job was negatively impacted by it (i.e. job loss or reduced hours).
posted by jason and the garlic knots at 4:54 AM on November 16, 2020 [1 favorite]

Your 401k investments won't evaporate. You will still be invested in whatever funds you are invested in. Those may be worth fewer $ in the short term, but unless you've been spectacularly reckless or we are all collectively hideously unlucky, those investments will be worth more when you retire than they are worth now. Their value will change over time, historically you would expect them to mostly go up and occasionally go down, sometimes by quite a bit. Check them at most once a year, and see how they're doing - not really to do anything with them until you get closer to retirement, but to assess whether you need to increase the amount you are investing towards retirement.

Treat your student loans as a separate problem. If you want to take a lower paying job, look into an income-based repayment if possible.
posted by plonkee at 2:11 AM on November 17, 2020