Author Topic: Use your 401k to pay off student loans  (Read 3666 times)

imadandylion

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Use your 401k to pay off student loans
« on: December 06, 2019, 12:53:03 AM »
I don't have student loans anymore but I would've never gone for this.

https://www.forbes.com/sites/zackfriedman/2019/12/05/student-loans-pay-off-retirement/amp/

Just... What.

Alternatepriorities

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Re: Use your 401k to pay off student loans
« Reply #1 on: December 06, 2019, 06:13:37 AM »
If Im reading that right it would have saved me 15-25% of the amount I paid on my student loans during the years before I was able to max out my 401k... Id have spent ~7.5k less in taxes on the money I used to repay the loans. All of which I would have saved either in a taxable account or in the early years by increasing my 401k contribution.

The other benefit for the non Mustachian is that it encourages people to start putting more money into their 401k early in their career for the purpose of repaying student loans... maybe they would keep contributing after the loans were paid off.

Boofinator

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Re: Use your 401k to pay off student loans
« Reply #2 on: December 06, 2019, 08:24:32 AM »
Wouldn't it make more sense to simply make tuition tax-deductible up to a certain amount? (I believe this was the case up to a certain amount of money and a certain threshold of income until the latest greatest tax law.)

Alternatepriorities

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Re: Use your 401k to pay off student loans
« Reply #3 on: December 06, 2019, 08:43:36 AM »
Wouldn't it make more sense to simply make tuition tax-deductible up to a certain amount? (I believe this was the case up to a certain amount of money and a certain threshold of income until the latest greatest tax law.)

The problem with making tuition tax deductible instead of the debt payments is many people have very little income while they are paying for tuition. It also doesn't help anyone who already borrowed money for school and is paying it back now. It seems like this plan would be most helpful to people who are not currently unable to maxing out their 401k but are probably making enough to do so with a bit of mustachianism... A fairer system would probably be to just make student loan payments tax deductible instead of routing it through the 401k but this way Washington can probably pretend it's revenue neutral even though the math says it can't be both successful and revenue neutral...

Daisyedwards800

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Re: Use your 401k to pay off student loans
« Reply #4 on: December 06, 2019, 08:47:27 AM »
As someone who has a little remaining student loan debt at a very low interest rate, I might do this if it came into being.  Tax - free?

slugline

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Re: Use your 401k to pay off student loans
« Reply #5 on: December 06, 2019, 08:52:21 AM »
Isn't the end result just like the mortgage interest deduction -- mostly a subsidy for high-income households?

robartsd

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Re: Use your 401k to pay off student loans
« Reply #6 on: December 06, 2019, 09:13:52 AM »
Isn't the end result just like the mortgage interest deduction -- mostly a subsidy for high-income households?
Yes and no. By proposing that this go through a 401k, it can benefit only those who: 1) have access to a 401k, 2) are not maxing it, and 3) have student loan payments. Those already saving the max in their 401k would got get any benefit, so some high-income households would be left out.

Wouldn't it make more sense to simply make tuition tax-deductible up to a certain amount? (I believe this was the case up to a certain amount of money and a certain threshold of income until the latest greatest tax law.)

The problem with making tuition tax deductible instead of the debt payments is many people have very little income while they are paying for tuition. It also doesn't help anyone who already borrowed money for school and is paying it back now. It seems like this plan would be most helpful to people who are not currently unable to maxing out their 401k but are probably making enough to do so with a bit of mustachianism... A fairer system would probably be to just make student loan payments tax deductible instead of routing it through the 401k but this way Washington can probably pretend it's revenue neutral even though the math says it can't be both successful and revenue neutral...
Also, student loans can be used to pay other costs of attending such as books and living expenses, not just tuition.

Boofinator

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Re: Use your 401k to pay off student loans
« Reply #7 on: December 06, 2019, 09:49:23 AM »
Wouldn't it make more sense to simply make tuition tax-deductible up to a certain amount? (I believe this was the case up to a certain amount of money and a certain threshold of income until the latest greatest tax law.)

The problem with making tuition tax deductible instead of the debt payments is many people have very little income while they are paying for tuition. It also doesn't help anyone who already borrowed money for school and is paying it back now. It seems like this plan would be most helpful to people who are not currently unable to maxing out their 401k but are probably making enough to do so with a bit of mustachianism... A fairer system would probably be to just make student loan payments tax deductible instead of routing it through the 401k but this way Washington can probably pretend it's revenue neutral even though the math says it can't be both successful and revenue neutral...

I guess I wasn't thorough in my original response, but to be clear, previously one could deduct both student loan interest and tuition (lines 33 and 34, respectively, of the 2016 1040). I don't currently have student loans, but it looks like there is still a student loan interest deduction available (https://www.irs.gov/taxtopics/tc456). Additionally, most college students are still dependents on their parents' tax returns, so having a low income for the student is somewhat irrelevant.

Come to think of it, the proposal, if I'm understanding correctly, would allow for tax-free dollars to pay off all student loans and tuition, not just student loan interest. This would be a huge cost savings for college for the highest earners, but only the ones who currently aren't saving money. In my opinion this is a perverse incentive, in that it makes college much cheaper for the high earners but barely cheaper at all for the lower earners.

imadandylion

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Re: Use your 401k to pay off student loans
« Reply #8 on: December 06, 2019, 12:26:56 PM »
Maybe I'm not sophisticated enough to understand the advantages, but this doesn't seem like a great proposition.

I can only agree that it's good to incentivize people to save in their 401ks with the rationale that it creates a habit... but I feel like that's also a problem in itself because then people wouldn't have retirement savings, which is already a problem. After all, it's a question a lot of people struggle with: Should they focus their efforts to pay off their student loans or save for retirement? A lot of people saddled with student loan debt delay retirement especially if their student loan debt amount and interest rates are so high that it makes more financial sense to pay down the principal as soon as possible, which may mean forgoing retirement savings entirely. I'm not sure how this would help that problem. It also seems like a very circular, out of the way method to pay off student loans... like putting in a middleman where the situation doesn't call for that.

If they use their 401k funds to pay for their student loans, what happens to the loans while they're funneling it into the 401k? Are they waiting to for a certain principal to deduct and then pay off the student loan in one go, or is it just a complicated transaction every time the employee gets a paycheck, where the funds are deducted from the paycheck, go into the 401k, and then immediately go into the student loans? I don't understand. Maybe I'm thinking too literally about how it works. But it just begs the question, why are 401ks even involved in the first place?

Plus, will the tax-free benefit even be advantageous if the student loan figure is really high, and when the interest rate is also really high? Maybe they'd just be breaking even, and it's not a benefit. I have an unpopular opinion that paying for memberships just to save money doesn't really often result in people getting that much of a net savings, (like having a membership at Costco). It seems similar. Except you're not paying any fee upfront other than student loan interest that accumulates and may become capitalized.

Then, it only benefits people who are able to get jobs. A small part of the student loan problem is the saturated market of skilled individuals seeking a finite quantity of available jobs. If these people take on jobs to make ends meet that don't offer the benefit of a 401k, or they have a hard time finding any variety of gainful employment, they do not benefit. So this isn't any better of a solution than to make student loan payments "tax-free" in itself without going through all this circular fuss. Better for some, not for all.

Ideas are dime in a dozen so why not focus on the ones that actually cast a wider net in terms of benefitting the population? I'm not sure why this was even noteworthy to Forbes. But again, maybe I'm just missing something and I just don't really understand the inner workings of why this is such a great idea, so I could probably be totally wrong about all this.
« Last Edit: December 06, 2019, 12:33:47 PM by imadandylion »

Fire2025

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Re: Use your 401k to pay off student loans
« Reply #9 on: December 06, 2019, 12:47:03 PM »
The primary way to get the full benefit, out of this program, is to stay a wage jockey for the life of your loan.  That's 20 to 30 years of dependancy.  Don't even think about a career or job that doesn't offer a 401k, or you will get 0 advantages.  I thought he was a libertarian??  Weird.

robartsd

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Re: Use your 401k to pay off student loans
« Reply #10 on: December 06, 2019, 02:19:28 PM »
The primary way to get the full benefit, out of this program, is to stay a wage jockey for the life of your loan.
I don't see anything that says you need to be contributing to the 401k to pay your student loan from it.

Fire2025

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Re: Use your 401k to pay off student loans
« Reply #11 on: December 06, 2019, 08:55:20 PM »
The primary way to get the full benefit, out of this program, is to stay a wage jockey for the life of your loan.
I don't see anything that says you need to be contributing to the 401k to pay your student loan from it.

I could be completely wrong, but it seems like the most optimized way to use this option would be to use pre-tax money to pay your student loan. 

That seems to work best if you're actively contributing, and pull some cash contributions out to pay your loan.  If you "cash out assets" to pay your student loan, that adds risk to your student loan payment plan.  If you leave more cash in your 401k, to use over time to pay your student loan, you will slowly loss the tax savings to inflation. 

Also once you severe service with the company that holds your 401k, you usually don't have the same access to the move money around in your 401k. At least that's been my experience.  But maybe they will make that possible, but I didn't see anything about that.

But again, I could be totally wrong, I'm not the brightest bulb on this tree.


robartsd

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Re: Use your 401k to pay off student loans
« Reply #12 on: December 09, 2019, 09:27:55 AM »
The primary way to get the full benefit, out of this program, is to stay a wage jockey for the life of your loan.
I don't see anything that says you need to be contributing to the 401k to pay your student loan from it.

I could be completely wrong, but it seems like the most optimized way to use this option would be to use pre-tax money to pay your student loan. 

That seems to work best if you're actively contributing, and pull some cash contributions out to pay your loan.  If you "cash out assets" to pay your student loan, that adds risk to your student loan payment plan.  If you leave more cash in your 401k, to use over time to pay your student loan, you will slowly loss the tax savings to inflation. 

Also once you severe service with the company that holds your 401k, you usually don't have the same access to the move money around in your 401k. At least that's been my experience.  But maybe they will make that possible, but I didn't see anything about that.

But again, I could be totally wrong, I'm not the brightest bulb on this tree.
If you retire, you can take distributions from your 401k. If you're younger than 59.5 you may pay a tax penalty for the privilege. Since this is just an idea, I doubt they've hammered out the mechanics of how the payment would be processed, but I imagine that if you took a post employment distribution to pay a student loan you could provide documentation to the IRS to show that the distribution paid the student loan and was exempt from the tax. You might have to leave the money in the 401k instead of rolling over into an IRA which could limit your investment options.

I don't understand what you mean by losing the tax savings to inflation. The proposal sounds like student loan payments through the 401k would be tax free regardless of when the payment to the student loan is made in relation to when the 401k contribution is made. The advantage of paying off the student loan over time is that the proposal caps the annual tax exempt student loan payment from the 401k and the student loan interest rate might be lower than expected risk adjusted investment returns.

Proud Foot

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Re: Use your 401k to pay off student loans
« Reply #13 on: January 06, 2020, 10:22:42 AM »
I feel like this is a start in the right direction but not a complete solution. The use of a 401k places a large constraint as it is necessary to have a job that offers a 401k.

 From the highlights in the article:
Quote

1) Tax-Free Money for College
2) Pay for Dependents
3) Tax-Free Employer-Sponsored Plans
4) No Cap on Student Loan Interest Deduction
5) Create Incentive to Save for Retirement

1 and 2) My biggest question will be if 401k plans will be required to allow in-service withdrawals to do this. If I am able to do an in-service withdrawal then I would contribute at least that amount to be able to withdrawal annually and keep it in a high interest savings account for my monthly payments. This help to reduce the pay down/save for retirement dilemma referenced by the author a little bit as the contributions save on your taxes and will (hopefully) have the employer match. I would also assume this $5,250 limit is individual meaning a married couple could combine for $10,500 annually. Obviously you would still want to increase your contributions beyond that amount and potentially increase loan payments above this amount.

4) I am all for removing the cap, however I think there should still be a phase out of the deduction. I feel like this is the only proposal which will benefit everyone who has student loans, however the actual amount of benefit will vary.

5) I personally would be all in on being able to receive my employer match as a Roth contribution.

Of the drawbacks the author mentioned I do not feel like the first two are very big objections, particularly if you consider his second objection being borrowers having to chose between saving for retirement or paying off student loans.


caleb

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Re: Use your 401k to pay off student loans
« Reply #14 on: January 06, 2020, 11:41:22 AM »
Yes and no. By proposing that this go through a 401k, it can benefit only those who: 1) have access to a 401k, 2) are not maxing it, and 3) have student loan payments. Those already saving the max in their 401k would got get any benefit, so some high-income households would be left out.

I think Paul's proposal is bizarrely focused in that it would provide a limited benefit (a little over $1000/yr tax reduction to a family in the 22% bracket) to a fairly arbitrarily chosen portion of the population (those paying for education who also have access to a 401k and want to use the entire amount on education expenses).  Why in the world is that the portion of the population best targeted with a smallish tax break?

If people want to use the tax code to address student debt, a far better choice would be to raise or eliminate the student loan deduction cap (currently $2500, so it's < $500 for most folks).  The political issue would be that the benefit would accrue mostly to the graduate educated professional class, but that seems like a more reasonable targeting than people who happen to have access to a 401k.
« Last Edit: January 06, 2020, 11:50:30 AM by caleb »

PDXTabs

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Re: Use your 401k to pay off student loans
« Reply #15 on: January 06, 2020, 04:05:47 PM »
Additionally, most college students are still dependents on their parents' tax returns, so having a low income for the student is somewhat irrelevant.

You are only a dependent for tax purposes if 50.1% of your support comes from your parents. That means, among other things, that your grants + loans + work study + regular income is less than what your parents gave you. I would be shocked if this was "most" college students.

joleran

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Re: Use your 401k to pay off student loans
« Reply #16 on: January 06, 2020, 05:43:15 PM »
You are only a dependent for tax purposes if 50.1% of your support comes from your parents. That means, among other things, that your grants + loans + work study + regular income is less than what your parents gave you. I would be shocked if this was "most" college students.

I'm shocked that student loans count as support for the dependent test, but it looks like you're right.  Scholarship amounts aren't though, and you can impute a rental income as if they lived at home.

PDXTabs

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Re: Use your 401k to pay off student loans
« Reply #17 on: January 06, 2020, 06:22:46 PM »
I'm shocked that student loans count as support for the dependent test, but it looks like you're right.  Scholarship amounts aren't though, and you can impute a rental income as if they lived at home.

The actual worksheet just looks at how much it cost for that person to live, then decides if you provided 50.1% of that number. From the IRS's point of view this seems pretty straight forward. It does have some weird side effects: it's not how much the student brought in that counts, it's how much they spent. If the student brings in $20K, but saves 10K, you only need to give them $5001 dollars to count them as your dependent. 
« Last Edit: January 06, 2020, 06:25:17 PM by PDXTabs »

Boofinator

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Re: Use your 401k to pay off student loans
« Reply #18 on: January 07, 2020, 07:42:15 AM »
Additionally, most college students are still dependents on their parents' tax returns, so having a low income for the student is somewhat irrelevant.

You are only a dependent for tax purposes if 50.1% of your support comes from your parents. That means, among other things, that your grants + loans + work study + regular income is less than what your parents gave you. I would be shocked if this was "most" college students.

Quite an interesting discussion, and I honestly haven't looked at the qualifications for being a dependent student.

I'm shocked that student loans count as support for the dependent test, but it looks like you're right.  Scholarship amounts aren't though, and you can impute a rental income as if they lived at home.

If "most" students do indeed qualify as dependents, my guess would be that the bolded part is what generally puts them over the edge.

Either way, much to think about for my upcoming years as a future parent to college students.