Your Child’s Debt Burden
While it’s difficult to see your child graduate with student loans, keep in mind there is a longer time frame to pay off these loans. If your cash flow allows, you can always help make loan payments after graduation.
This article is intended for informational purposes and is not intended as tax or financial advice.
Student Loan Assistance Is Now A Better Deal For Employees
One big reason student loan repayment assistance is primed to continue growing, experts say, is because it makes more sense for the companies’ bottom lines now.
Before Congress passed the CARES Act in 2020, employer contributions toward an employee’s student loans were considered part of the employees income, meaning employees had to pay income tax on whatever amount of student loan repayment assistance they received. Not anymore.
An employer can now pay up to $5,250 per year toward an employee’s student loans on a tax-free basis through 2025. Plus, the employer now gets a payroll tax exclusion on the contribution amount.
Prior to the implementation of this new tax break, an employer’s annual contribution of $5,250 would have cost both the company and the employee about $400 in payroll taxes, according to the national law firm Bradley. Moreover, an employee with a 22% federal income tax rate would owe $1,155 in federal income taxes. So in the end, the employee ends up with a net benefit of just about $3,695. And the employer would have paid $5,650 for it. Now, every dollar a company spends on a qualified student loan repayment program goes toward its intended purpose paying down debt.
That got a lot of employers attention, says Scott Thompson, CEO at Tuition.io, an education assistance benefits platform. Over the last few years, as we’ve talked with more and more employers, one of the impediments has always been, ‘why is this a taxable benefit?'”
When To Pay Off Student Loans
Paying off student loans first can take some time, but for many borrowers, it can relieve a lot of stress and free up more cash for other goals, including investing. It can also make your life feel a little less complicated. You should consider paying off your student loans if you have high interest rates, you have an unpredictable cash flow or youre looking to remove debt from your finances.
Pros:
- Your debt-to-income ratio will improve, making it easier to qualify for a mortgage.
Cons:
- It can take several years to pay off your student loans, even with extra payments.
- Its unnecessary if youre working toward loan forgiveness or repayment assistance.
- You wont be able to maximize the student loan interest deduction.
Best for:
- People whose top priority is to be debt-free.
- Borrowers with high-interest student loans .
- People hoping to purchase a home but who cant because of a high DTI.
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Lower Your Interest Rate
If you are currently serving on active-duty you are eligible to have the interest rate lowered to 6% on all student loans taken out prior to your military service. This benefit applies to both your federal and private student loans and is available for all active-duty servicemembers, regardless of where you serve. Most borrowers on active-duty will qualify for this benefit.
To obtain an interest rate reduction under the Servicemembers Civil Relief Act , contact your servicer and ask about this option directly. You will be required to notify your servicer in writing and provide your servicer with proof of your active-duty status in the form of orders from your commanding officer.
Learn more about the Servicemembers Civil Relief Act and other benefits for servicemembers with student loans from the U.S. Department of Education.
You may also be eligible for other benefits available to servicemembers, such as military deferment, as well as other generally available repayment options such as Income-Driven Repayment
Why A 401 Loan Is Typically A Better Option To Pay Off Your Student Loans Than An Early Withdrawal
If after weighing the pros and cons, you still want to use your 401 to pay off your student loans, then Gillette suggests considering taking out a 401 loan instead of a withdrawal.
Why?
Because 401 loans offer several advantages that good old withdrawals dont offer.
These include
- Not having to pay a 10% tax penalty. Since youll be borrowing money, not withdrawing it, you wont be penalized by the IRS.
- Youll save money on taxes. The borrowed amount wont count as part of your ordinary income for that year, so you wont have to pay any taxes on it.
- Lower impact on your long-term retirement plan. Like Gillette mentioned, since youll be paying yourself back with interest borrowing money from your 401 wont set you back, in terms of future earnings, as much as a plain withdrawal.
But even if a 401 loan is a better option than withdrawing the funds, there are certain considerations you need to keep in mind before taking the plunge.
These are some of the most important ones:
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Commonbond Disclosures: Private In
Offered terms are subject to change and state law restriction. Loans are offered by CommonBond Lending, LLC , NMLS Consumer Access . If you are approved for a loan, the interest rate offered will depend on your credit profile, your application, the loan term selected and will be within the ranges of rates shown. If you choose to complete an application, we will conduct a hard credit pull, which may affect your credit score. All Annual Percentage Rates displayed assume borrowers enroll in auto pay and account for the 0.25% reduction in interest rate. All variable rates are based on a 1-month LIBOR assumption of 0.15% effective Jan 1, 2021 and may increase after consummation.
Why The Debt Snowball Works
The idea behind the debt snowball is two-fold. It gives you an outlined method for tackling your debt, and as you knock out those smaller student loans you will feel a psychological boost from having fewer and fewer debts to pay. Sticking with the debt snowball can build momentum that keeps you motivated.
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Request Deferment Or Forbearance
Another option for federal and some private student loans is deferment or forbearance. Both of these options pause your loan payments temporarily if youre experiencing financial hardship, have gone back to school or have another qualifying reason.
The downside of postponing your loan payments, however, is that your balance will likely continue to grow due to interest charges. The only exception is subsidized loans, which dont accrue interest during deferment.
But for all other loan types, pausing payments through deferment or forbearance could be a temporary Band-Aid, rather than a long-term solution.
Loans Reduce Your 401 Earnings
If you borrow from your 401, you limit the potential growth of your retirement assets. For example, if you take out a loan for $10,000 from your 401, that $10,000 won’t be earning any interest for you during the life of the loan. And youll lose not only the accruing interest amount, but also any compound interest.
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Should You Use Your 401 To Pay Off Student Loans
Modified date: Jan. 26, 2022
If youve been working for a while and contributing to your companys 401, you might feel tempted to use some of that cash to wipe out your student loans and I dont blame you.
Saving thousands on interest and allocating those funds toward things, like buying a house or beefing up your savings, sounds like a good plan, especially if youre light-years away from retirement.
But even if it seems like a good idea, dipping into your 401 before youre supposed to, shouldnt be taken lightly. Not only youll be cutting yourself short from future earnings, but could also face a hefty tax bill.
Whats Ahead:
Before You Apply For A 401 Loan
Amy Lynn Richardson, CFP with Schwab Intelligent Portfolios, says that the most important thing before touching your 401 is to have a plan to replenish those funds.
This might mean reviewing your budget and identifying areas where you could spend less so that you can increase your 401 contributions.
Kenneth B. Waltzer, a member of theFinancial Planning Association and managing director atKCS Wealth Advisory, adds that you also
need to be very confident that you will remain at your current employer for at least long enough to fully pay off the 401 loan.
This will help you avoid the financial burden of triggering an early withdrawal.
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What To Consider When Using Your 401 To Pay Off Student Loans
Most experts generally frown upon using a 401 to pay off student loans because of the risks. Sure, you get to keep on top of your payment schedule and maybe get out of student loan debt sooner, but the downsides are huge.
For one, youll have to pay extra taxes typically 20% of the withdrawal amount if you withdraw your 401 funds before age 59.5. So if youre 35 years old and take out $15,000 from your 401, youll have to pay $3,000 in taxes. If youre lucky, you may see some of that money back if you end up getting a tax refund.
Not only will there be taxes, but if you withdraw money from your 401 before age 59.5, you usually will need to pay an extra 10% penalty to the IRS when filing your tax return. That means if you withdraw $15,000, youll lose out on $4,500 in taxes and penalties. In other words, thats $4,500 less to go toward your student loans.
Perhaps the biggest downside is that youll have a smaller nest egg when you retire. If you take money out of your 401, that money can no longer be invested and allowed to grow until you reach retirement age. Think about how much $15,000 can grow in the next 20 to 30 years. It could be a difference of tens, if not hundreds, of thousands of dollars by the time youre ready to retire.
All this to say, paying off your student loans may feel great, but in the long term, you could be paying more in taxes and paying the price of the opportunity cost of not investing the money in your retirement account.
Should You Use A 401 To Pay Off Debt
In some cases, it could be beneficial to cash out a portion of your 401 to pay off a loan with an 18% to 20% interest rate, says Paul Palazzo, CFP, COA, managing director of financial planning at Altfest Personal Wealth Management.
For debts with lower interest rates, such as a home mortgage or student loan, taking a 401 withdrawal, and paying both income taxes and a possible 10% penalty on it, would make little financial sense.
Thats especially true when you consider that youd be sacrificing $45,000 in retirement savings, plus their future earnings.
Fortunately, there are some alternatives.
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Federal Direct Consolidation Loans
If you are currently in default on a federal student loan and plan to go back to school, you may benefit from a direct consolidation loan. If you cannot afford to pay off your loan in full, this is the fastest way to get out of default and restore your eligibility for federal student aid.
Through consolidation, your defaulted loans are paid off by a new loan with new repayment terms. If you do not make any payments on your defaulted loan prior to consolidating them, you will berequired to sign-up immediately for one of the alternative payment plans available to all federal student loan borrowers.
Ask your debt collector for specific information about fees. The costs associated with bringing your loan out of default may vary substantially depending on your individual circumstances.
Before you consolidate, make sure you understand the terms of this new payment arrangement and the terms of your new loan. If you default again, your only option to get out of default is to agree to a repayment plan with your debt collector.
Loan rehabilitation may be a better option for some borrowers however, rehabilitation can take up to 10 months to complete. Like consolidation, loan rehabilitation restores your federal student aid eligibility but will also remove the default notation from your credit history. And in some cases, it can be cheaper than consolidation.
Keep Track Of Your Monthly Budget
While the importance of budgeting your money might be old news, it can be helpful to track your income and expenses when you have student loan debt. Whether you use a spreadsheet or a budget-tracking app, getting a handle on your monthly cash flow can help you earmark money for your student loan bills.
You might identify areas where you can cut down on spending or feel inspired to earn more money with a side hustle.
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Exceptions For 401 Only
- You leave your job the year you turn 55 or later .
- The 401 is divided in a divorce under whats known as a Qualified Domestic Relations Order.
- You overcontributed to your 401.
Theres also an exception to the early withdrawal penalty for a 401 if you receive a hardship distribution. This is money taken out of your 401 to meet an immediate and heavy financial need, according to the IRS, and could include things like repairing damage to your home after a natural disaster, covering funeral expenses for a loved one, or paying rent to avoid eviction. And youre only allowed to take out the exact amount needed for these expenses.
But even as it becomes easier to access your 401, remember that youre the one who has to live off that money when you retire. So be careful about what you call an emergency and save your 401 for later.
How Does A 401 Loan Work
Withdrawing money from a 401 to pay student loans is almost always a terrible idea because taking money out of your retirement account before youre 59½ can trigger a 10 percent penalty on withdrawn funds. This penalty is charged in addition to income tax youd owe on the money taken out of your account.
Rather than withdrawing cash, you could tap into your retirement savings to repay student debt by borrowing money from your 401. Youd have to pay principal and interest on your 401 loan, but would be paying the money back to your own retirement account instead of enriching a lender.
When you borrow from a 401, repayment terms are determined based on how much you borrow. Your plan can set its own interest rate and you must repay the entire balance within five years.
You can use the money for anything youd like, so you could borrow from your 401 to pay off federal or private student loans.
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Compare Student Loan Refinance Lenders
Once you have all of your student loan debt gathered up, the first thing you will want to do when looking to refinance is to compare lenders. You can compare interest rates, repayment terms, and other benefits such as interest rate deductions for enrollment in automatic payments, cosigner release, and customer service.
What About 401 Loans
Another mistake people make is taking out a 401 loan to pay off their debtbut you end up having to pay yourself back with interest. Yuck! And 401 loans can backfire quickly. If you lose your job, that loan needs to be paid back within 60 days. If its not, youll be forced to payyou guessed ita 10% penalty, plus taxes. But the truth is, you cant borrow your way out of debt, so you should avoid loans altogether.
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Lender And Bonus Disclosure
All rates listed represent APR range. Commonbond: If you refinance over $100,000 through this site, $500 of the cash bonus listed above is provided directly by Student Loan Planner.
CommonBond Disclosures: Refinancing
Offered terms are subject to change and state law restriction. Loans are offered by CommonBond Lending, LLC , NMLS Consumer Access. If you are approved for a loan, the interest rate offered will depend on your credit profile, your application, the loan term selected and will be within the ranges of rates shown. If you choose to complete an application, we will conduct a hard credit pull, which may affect your credit score. All Annual Percentage Rates displayed assume borrowers enroll in auto pay and account for the 0.25% reduction in interest rate. All variable rates are based on a 1-month LIBOR assumption of 0.15% effective Jan 1, 2021 and may increase after consummation.
CommonBond Disclosures: Private, In-School Loans
Student Loan Planner® Disclosures
If You Have Private Student Loans
Look into student loan refinancing
Unlike loan consolidation which bundles all your student loans into one, with astudent loan refinance youre taking out a new loan with a new term and interest rate, to pay off your old debt.
Now that youve been working for a few years, chances are you have a higher credit score than when you first took out your private loans. If thats the case, you could qualify for a better term, plus a lower interest rate, which can make your monthly payments cheaper.
Read more: Student Loan Refinance Options
See if your employer offers student loan repayment assistance
Finally, ask your employer if they offer assistance with student loans. The CARES Act offers tax incentives for employers who offer this benefit, and the Consolidated Appropriations Act extended this benefit through 2025.
Employers may pay up to $5,250 of student loan debt a year per employee. The employee doesnt have to pay income tax on this money and the company also benefits from a payroll tax exclusion. Your employer may not know about this new benefit, so bring it up to your manager and HR department.
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