Taxes & 401K/IRA

Question

Here's the scenario I am thinking about in my head:

1. Contribute money into a 401K/IRA (and then roll 401K into IRA) - save on income taxes
2. Before my second year of B-School (when I only have internship income), do a hardship withdrawal for tuition for 2nd year (under assumption that my IRA account returns will be less than interest cost of loans). This assumes that I will not be subject to early withdrawal penalty.

Would that work?

nink · Answer

I don't get it.

If you are putting money into the traditional IRA account/401k so you can take the above the line deduction on your tax return, you will still pay tax on your early withdrawal (even for hardship) later on. So why put the money into the 401k (rollover to IRA) account to pay for tuition later?

lhomme · Answer

Is there an early withdrawal penalty for 401K/IRA for hardship (tuition)? What I was reading online seemed conflicting on that point.

dc3828102 · Answer

Not too great with taxes and what not... But I wonder if this is the strategy. For the simplicity of the argument, the top marginal tax rate this lhomme has to pay is at 35% and the lowest marginal tax rate is at 15%. By contributing to 401k/IRA, lhomme won't have to pay any amount in 35% bracket. Before 2nd year, lhomme dips into the 401k/IRA but since his income dipped substantially during his full-time b-school endeavor, rather than paying that 35% marginal tax for the amount he contributed to 401k, he pays 15%. Then even with 10% withdrawal penalty, lhomme can come out a head a bit...

nink · Answer

If someone is subject to 35% tax bracket, then he/she can not contribute to IRA account (to begin with) due to income limitation.

If you qualify for hardship rule, then only thing you will have to pay are taxes and maybe 10% fee (only if adjusted qualified education expense is less than taxable portion of IRA distribution). But usually, you have to prove that you've exhausted all your other options before they will let you qualify for hardship rule.

dc3828102 · Answer

That might be the tax maneuver.

401k doesn't seem to have contribution limit. Max out your 401k contribution this year, rollover to IRA next year and then make a withdrawal. It seems that you are still subject to 10% withdrawal penalty so you may save a tiny bit of money.

That being said, I'm looking at the income bracket matrix right now and it looks like the amount that you save by doing this maneuver is really not worth the cost as you get hit with the top marginal rate only if you make more than 373k.

On the other hand, you are making a guaranteed return of whatever the prevailing interest rate will be on your student loan...

It looks like a lot of trouble for not a lot of savings.

People who engaged in this maneuver mid-2007 would've made a killing however.

dc3828102 · Answer

Here's a spreadsheet that can calculate the payoff from such a maneuver. I made numerous assumptions to ease the calculation. There may also be some errors as well. :wink:

Change the income amount as well as 401k contribution to calculate the ultimate amount saved. edit: Changed the top marginal rate correctly to 35%.

lhomme · Answer

Whoa - good thoughts. I guess my key assumption was that there wouldn't be a penalty for early withdrawal for tuition, which seems flawed. With the penalty, the complexity doesn't really seem worth it.

dc3828102 · Answer

If you make 390k+, then the tax saving would be more than $2000. But if you make 390k+, what are you doing by going to business school?

nink · Answer

401k has contribution limit.

What makes this entire argument a moot pt is that 
1) Anyone subject to such high tax rate would not need to dip into retirement plan to pay for bschool
2) IRS would never buy into hardship withdrawal argument
3) Probably will violate substance-over-form doctrine

aalba005 · Answer

401k limit is 16,500 or 50% of your pay, whichever is lower.

You can withdraw from IRA for qualified Education Expenses without 10% penalty.

"However, you can take distributions from your IRAs for qualified higher education expenses without having to pay the 10% additional tax. You may owe income tax on at least part of the amount distributed, but you may not have to pay the 10% additional tax."

Qualified expenses include tuition, room and board, books.

You can go to www . irs . gov / publications / p970/ ch09.html (no spaces) to clarify some more.

dc3828102 · Answer

Meant to say contribution limit as far as the top end income is concerned.

But, the statement that I made, as stated is incorrect.

lhomme · Answer

Based on that link, it seems like you could withdraw it without penalty to pay tuition and housing. That said, withdrawing enough to do so would actually bring me pretty close to the same tax rate anyway (especially plus internship income), so it would be less of a lower taxes maneuver than a bet that market returns will be less than student loan interest rates (net taxes). That "bet" worked wonders for me in 2007-2008 (pay off debt. vs. invest in market), but probably isn't that meaningful now.

socalmike · Answer

Anyone know how I could pull from my Traditional/Roth IRA and 401k to pay for tuition and housing without incurring the early withdrawal fee? In essence, how would I go about this? Is there any form or documentation that needs to be completed?

socalmike · Answer

If you withdraw from a 401k/IRA to pay for school, you don't incur the 10% penalty but you will need to record the amount as income on your taxes.

https://www.ehow.com/how_5686257_withdra ... chool.html

estreet · Answer

401k and IRA don't have the same rules, so carefully research before going this route.

avohden · Answer

Hi - I answered a similar question with the links to the IRS websites regarding the 10% penalty on early withdrawals.

see  https://gmatclub.com/forum/straight-answer-401k-to-pay-for-mba-tuition-penalty-free-129714.html#p1274042

tanken · Answer

I am pretty sure you can withdraw it with no penalty. 
I think my brother did it in that way.
I will find out how was the process.

VeritasPrepMike · Answer

In theory it would work, but why would you want to do this? Once you take the money out of your retirement account it can be very difficult and costly to get it back in. Saving for retirement is hard enough. Think of it this way, no one will loan you money for retirement. But just about everyone will lend you money to go to business school. My advice is to take loans and avoid messing around with your retirement accounts. You will regret it when you are 55 and need money for retirement.

Taxes & 401K/IRA

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