Using retirement funds to pay for law school? Forum

[UCInfo]

For those of you who have worked for several years, are you planning to tap retirement accounts to defray law school costs? Traditional financial advice has discouraged this, usually in instances when parents consider using retirement money to pay for their kids' tuition. I understand that logic since parents with college-age kids may only have 10-15 years of employment left. But what about when you use your own retirement money to pay for your tuition and you have 30 years of employment left?

I'll be in the 15% tax bracket in school, so taxes on retirement account withdrawals will be relatively low -- as low or lower than they will be in retirement. Health willing, I'll have 30 years of work left to rebuild my retirement funds, and a higher salary over that period should allow me to put more toward savings than I do now. I will attend a T10 school and probably have less than $40K in debt under this plan.

On the downside, I'd lose the compounding effect for as long as it takes me to rebuild my accounts to the level they would have been at. It is difficult to know the effect of that without knowing the rate of return.

Any thoughts?

[tesoro]

For those of you who have worked for several years, are you planning to tap retirement accounts to defray law school costs? Traditional financial advice has discouraged this, usually in instances when parents consider using retirement money to pay for their kids' tuition. I understand that logic since parents with college-age kids may only have 10-15 years of employment left. But what about when you use your own retirement money to pay for your tuition and you have 30 years of employment left?

I'll be in the 15% tax bracket in school, so taxes on retirement account withdrawals will be relatively low -- as low or lower than they will be in retirement. Health willing, I'll have 30 years of work left to rebuild my retirement funds, and a higher salary over that period should allow me to put more toward savings than I do now. I will attend a T10 school and probably have less than $40K in debt under this plan.

On the downside, I'd lose the compounding effect for as long as it takes me to rebuild my accounts to the level they would have been at. It is difficult to know the effect of that without knowing the rate of return.

Any thoughts?

I don't have much advice to add since I'm not a financial guru. I remember this being discussed at length recently though - run a search for retirement, there's a good discussion a few pages back.

Also, be careful about using the assumption of a higher salary as a justification to withdraw. You'll have to outperform at least 50% of your peers, most of which were top 1-2% scorers on the LSAT and consistantly made A's in college, at a T10 in order to make that a good bet (still not a guarantee).

[sanpiero]

Can make withdrawals penalty-free from 401k/IRA accounts to cover education expenses?

[PoliticalJunkie]

I'm in the same boat and have already moved most of my money from my retirement account into a savings. I didn't move all since it would have shut me out of the particular mutual fund that I'm in since they are not taking any more new investors.

I think it depends on the numbers and the fundamental question of if the money you take out will substantially lower your debt burden. For me it will (lowering a total tuition cost (assuming sticker price, from 150K to about 70K and a total law school debt - including COL - to about 90-95K).

This is how I made my decision, Hope it helps!

[tesoro]

I think the consensus on the other thread was to keep an eye on the rate of return on your retirement account and compare it to the interest rate on loans. The day your retirement account yields a lower rate than the interest on the loans would be a good day to withdraw money from the account.

[UCInfo]

tesoro -- Thanks for the advice. My hope is that at the very least I'd have a higher salary than I do now, enabling me to put more money toward retirement. A job that pays half a Big Law salary would still be more than I now earn. Another thought I had was that if I can't get a higher-paying job, I'd much rather have $40K in debt than $100K in debt.

sanpiero -- You can use IRA withdrawals for higher education without paying the 10% penalty.

[sanpiero]

If the withdrawals would be penalty-free, my advice would be to withdrawal enough to cover any debt above the $20,500 per annum Stafford limit. The incremental debt will likely be GradPlus loans at 8.5%. The Stafford loans are only 6.8%, and $8.5k of the $20.5k is subsidized (interest doesn't accrue until after graduation).

Your 401k likely will not provide after-tax returns above the 8.5% debt rate. If you can't generate RORs above the interest rate of new debt, use the cash to pay. Historically, the S&P has returned 8-10% annually (~6-8% after-tax) but the past decade has been nowhere near as friendly to investors. Why take the risk of hoping for 8.5%+ after-tax returns over the next 3, 10, or 30 years?

EDIT: corrected subsidized Stafford figure

[UCInfo]

Thanks, everyone.

Good point, sanpiero. If the rates were at 3% like they used to be, it'd be easier to assume six-figure debt. But with PLUS at 8.5%, you're probably right about not taking the chance the market will beat that rate. Perhaps the best plan is to limit loans to Staffords (and hope for subsidized Staffords), and then use retirement/savings to pay the rest of costs.

[ughOSU]

whenever you can avoid the private loans, do it. I will probably be living off of my savings my first year. In order to take your money out of your 401k without the penalty, I think you first need to roll it over into an IRA. I'm gonna talk to someone about this today, and set up my 2009 IRA. I'll re-post later today and let you all know what the deal is. Right now, if you have very low COL you may want to start contributing a much larger percentage of your paycheck to your 401k account, as you can take this money out next year when you will have significantly lower income, and will be a full time student. You can contribute up to 100% of your pay check.

e: idiom error

ee: they don't do this on saturdays... will let everyone know when I find out.

[UCInfo]

The deal is this: whenever you leave your employer, you can roll your 401k into an IRA. Only IRAs allow you to withdraw for education without paying the 10% penalty.

You bring up another good point, which is that if you are at the 25% marginal tax rate now and can afford to contribute more to your 401k, you should do so. Most of us will be at the 15% rate in school. It would seem at the very least that you would get a 10% return on your money as long as you wait to withdraw in the year you have no income.

[Renzo]

Take the loans. Chances are good that your investments will appreciate over the next few years as the economy recovers. If you get out and get a good job, you can divert resources to paying the loans off instead of replenishing the retirement fund, and will have the benefit of the compounded interest made while in school. If you get out and the worst-case comes true, you'll still have the retirement funds as a cushion to live and the loans can be deferred temporarily. In any in-between case, you'll be able to consolidate all your loans at a much lower rate than 8% (probably), and the rate of return on your retirement investments will likely be higher than your post-consolidation rate.

As for tax advantages, even if the IRA withdrawal is penalty-free, you pay taxes on it as income. If you take the loans, they are not income and not taxable, and in most cases educational loan interest is tax-deductible.

[UCInfo]

Renzo -- Thanks for the other perspective.

I've done the consolidation calculation, and even including my very low interest undergraduate loan, the blended rate works out to be 7.x%. Consolidation doesn't provide the same benefit that it did when the student loan rates were variable.

I am concerned about not getting any deduction from student loan interest. The deduction starts phasing out for income levels of $55,000/$115,000 and then altogether eliminated at $70,000/$145,000.

I still think there'd be a huge tax advantage to taking out the money in school. You'd pay only 15% in taxes in school. Comparably, if you took it out after school, you'd pay 35% to 38% in taxes.

[Renzo]

Renzo -- Thanks for the other perspective.

I've done the consolidation calculation, and even including my very low interest undergraduate loan, the blended rate works out to be 7.x%. Consolidation doesn't provide the same benefit that it did when the student loan rates were variable.

I am concerned about not getting any deduction from student loan interest. The deduction starts phasing out for income levels of $55,000/$115,000 and then altogether eliminated at $70,000/$145,000.

I still think there'd be a huge tax advantage to taking out the money in school. You'd pay only 15% in taxes in school. Comparably, if you took it out after school, you'd pay 35% to 38% in taxes.

True, but you might not realize that tax rate until you retire (assuming everything works out).

For full disclosure, I took both a IRA withdrawal and loans for the first semester, then put the cash in the bank and paid tuition with the loans. But my circumstance were a little unusual (I have a family), so I needed to know I'd have some ready cash at hand.

[ughOSU]

The deal is this: whenever you leave your employer, you can roll your 401k into an IRA. Only IRAs allow you to withdraw for education without paying the 10% penalty.

That's right, but if you're in my situation and haven't been contributing to a 401k for calendar year 2009, you can set up an IRA and contribute up to $5000 to it in calendar year 2010, and have that income deducted from your 2009 taxes, so long as you set up the IRA before you file your 2009 tax returns. Then when you stop working, you can roll over your 401k into an IRA (I think you could probably roll it over into the same one).

Renzo,

you're right that your strategy may turn out better in the end, but it is riskier. It's a question of what you're more comfortable with, how long you've been working, and how you're currently using your 401k. For example, I am contributing to mine with the knowledge that I'm not saving for the long term, but rather primarily for the purpose of staying in a low income bracket for two years rather than one. I would not recommend that someone who has been working for 10 years and has 100k saved up liquidate his/her life savings, but for a lot of us who haven't been working too long, I think it makes sense.

[MTal]

For those of you who have worked for several years, are you planning to tap retirement accounts to defray law school costs? Traditional financial advice has discouraged this, usually in instances when parents consider using retirement money to pay for their kids' tuition. I understand that logic since parents with college-age kids may only have 10-15 years of employment left. But what about when you use your own retirement money to pay for your tuition and you have 30 years of employment left?

I'll be in the 15% tax bracket in school, so taxes on retirement account withdrawals will be relatively low -- as low or lower than they will be in retirement. Health willing, I'll have 30 years of work left to rebuild my retirement funds, and a higher salary over that period should allow me to put more toward savings than I do now. I will attend a T10 school and probably have less than $40K in debt under this plan.

On the downside, I'd lose the compounding effect for as long as it takes me to rebuild my accounts to the level they would have been at. It is difficult to know the effect of that without knowing the rate of return.

Any thoughts?

I have my series 7 and 63 licenses. I can tell you that this is a horrible...HORRIBLE idea.

[Anonymous Loser]

As for tax advantages, even if the IRA withdrawal is penalty-free, you pay taxes on it as income. If you take the loans, they are not income and not taxable, and in most cases educational loan interest is tax-deductible.

To clarify, contributions to Roth IRA's can be withdrawn at any time, for any reason, and are not taxable. Earnings on such accounts, however, may be taxable.

[ughOSU]

As for tax advantages, even if the IRA withdrawal is penalty-free, you pay taxes on it as income. If you take the loans, they are not income and not taxable, and in most cases educational loan interest is tax-deductible.

To clarify, contributions to Roth IRA's can be withdrawn at any time, for any reason, and are not taxable. Earnings on such accounts, however, may be taxable.

Roth IRAs are a different animal, and your contribution to Roth IRAs were taxed as income before you made the contribution. So yes, you can take the money out, but it was already taxed as income, whereas with traditional IRAs, the money was not taxed when you put it in. I would suppose that earnings on Roth IRAs would be taxed upon withdrawal. I do not have my series 7 or 63, so do not take this as financial advice. I may be completely wrong. MTal?

[md;jdwannabe]

I have been offered an interest only loan at a great rate for at least a 5 year period based on liquid assets. That may be something to examine.

[MTal]

So yes, you can take the money out, but it was already taxed as income, whereas with traditional IRAs, the money was not taxed when you put it in. I would suppose that earnings on Roth IRAs would be taxed upon withdrawal. I do not have my series 7 or 63, so do not take this as financial advice. I may be completely wrong. MTal?

Yes, you are essentially correct. Appreciation on Roth's is taxed, principal is not. When it comes to distributions, principal is taken out first for tax purposes.

*Note: This is not to be construed as financial advice. Speak with your tax adviser to see what choices are right for you.

[Renzo]

Renzo,

you're right that your strategy may turn out better in the end, but it is riskier. .

Hells yeah! Morgan Stanley, here I come!! Anyone wanna let me run their hedge fund?