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# What are you going to do with your 401K?

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Senior Manager
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11 Nov 2006, 08:56
I wonder whether there is a way that I can use the 401k to pay for my tuition without paying the extra 10% tax.

Or, would it be better to use the loan and to leave the 401K alone so that it can accumulate a return which is typically higher than the interest of the student Loan?

Last edited by died4me on 11 Nov 2006, 15:55, edited 1 time in total.
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22 Jan 2009, 09:26
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Let's say you have a large cap stock fund in your 401(k) that charges an expense ratio of 1.00%. Now both Vanguard and Fidelity offer index funds tracking a broad large cap stock index for expense rations ranging from 0.10% to 0.25%.

You can't predict the performance of the stock market, but over the long run your index fund investment will save you at least 0.75% in expenses year after year guaranteed. As it is, most funds try to beat the performance of a broad market index, and typically don't succeed over the long term anyway.

IHateTheGMAT is going to knock me for this, but I don't believe in stock picking. Yet, I do believe in manager risk. So in my opinion, an index fund is an ideal investment. However, please note that I am not a licensed investment advisor, so take my advice with a grain of salt and perhaps check our vanguard.com and fidelity.com?

ninkorn wrote:
What's the benefit of opening a higher cost rollover account vs lower cost one? Performance of the fund?
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22 Jan 2009, 09:47
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Yes, you do it after you leave.

You call your 401(k) plan administrator and tell them you will be rolling over your funds into an IRA elsewhere. Then you open a Rollover IRA wherever you want, and get instructions so your 401(k) plan administrator can make out a check to the trustee of your new IRA (trustee here just means the investment manager or brokerage you choose).

This is the only really important thing, make sure the 401(k) plan administrator makes out the check for your 401(k) balance to your IRA trustee and NOT to you. Otherwise you will get hit with income taxes. So confirm that your 401(k) plan administrator is doing a direct rollover, or what is called a "trustee to trustee transfer" of funds.

Some 401(k) administrators will charge a fee, perhaps $30-$50 to close out your 401(k). If they do so then they suck, but you can only blame your company HR department.

May be we need to do a Financial Aid chat or something?

isa wrote:
So timeline wise, if you would do this right after you leave the current employer? And are there any penalties for moving the funds into a rollover IRA?

Thanks
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11 Nov 2006, 11:18
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opps... 401k provider
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22 Jan 2009, 09:14
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When you leave your current employer, if the balance in your 401(k), or what's left of it given what's going on in the market , exceeds \$2,500 you may roll it over into an IRA at virtually any brokerage. The advantage of doing this is that you can manage your 401(k) investments in one place along with any other taxable investments you might have at another financial institution. This way you get to choose investment options that may not currently be offered within your 401(k), too!

The second advantage is that most 401(k) plans offer ridiculously expensive fund choices, and rolling your money over into a Rollover IRA with a low-cost investment manager or brokerage such as Vanguard or Fidelity (as long as you meet fund minimums) for instance would make your investment expenses considerably lower than what they might be now. You have the choice of liquidating your 401(k) and using the proceeds to buy similar (often cheaper) funds and transferring the shares in funds currently in your 401(k) "in kind" into a Rollover IRA. I would recommend liquidating and buying into a similar fund over an "in kind" transfer.

If need be, you can also withdraw money from your rollover IRA to meet eligible educational expenses. You'll pay income tax for sure, but you won't be hit with the 10% penalty the IRS levies on other early (i.e. before you're 59+ years old) distributions from IRA accounts. So it's also a somewhat decent "worst case scenario" backup for MBA funding.

disclaimer: I have all my money at Vanguard and will shill for them at every available opportunity
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11 Nov 2006, 10:57
I'm cashing mine out and paying off some college credit card debt. But yes... education actually is a withdrawal that can exempt you from the 10% early withdrawal penlty. It needs to be post secondary and accredited... I would imagine business school would fit the bill. Check the IRS. I used to work in 401k for Fidelity. We didn't deal with the taxable implications... thats your responsiblity at tax time.
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11 Nov 2006, 11:14
You might want to verify that 401(k) distributions used to pay higher education expenses are excepted from the 10% additional tax.

Please see IRS Topic 558- Tax on Early Distributions from Retirement Plans.

The following exceptions apply only to distributions from IRAs:

Distributions equal to or less than your qualified higher education expenses,
Distributions made to pay for a firstâ€“time home purchase, and
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11 Nov 2006, 11:17
Yeah... the first one on your list. But you qualify that at tax time. Your IRA provider will automatically withhold 20% from any distribution. If you wish to get around the withholding and pay the tax at tax time you need to roll over to an IRA where you will not have a manditory withholding but can withhold 10% + if you wish from your distribution.
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11 Nov 2006, 13:08
I think you might have to roll it over into a roll over ira before you do that - unless you can just do it direct from a 401k. But my girlfriend just did this to pay for the rest of her college (she is a senior) and she will be tax exempt from the 10% rule - however you must keep in mind that if you use it to pay for education and you pull it from your IRA that it will count as income and you will have to pay taxes on that.

Having them withhold some money for taxes at the end of the year is a smart idea (unless you dont have much in your IRA then it probably doesnt matter).

But it is something I am contemplating as well.
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11 Nov 2006, 14:08
Interesting. I had no idea I could tap 401k. Wonder if I can tap SEP-IRAs as well. I have far more in the SEP-IRA than the 401k, just because I was self employed for a long time. I've got almost two years tuition sitting there.
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11 Nov 2006, 14:17
Difference between the 401k and the IRA is the "manditory withholding"

IRA: No Manditory withholding, optional 10% or greater withholding

401k: Manditory 20% withholding

Come tax time... Same taxable implications... Ordinary income + 10% for early withdrawal unless an exemption applies...

I have worked in both 401k and brokerage... I know what I am talking about guys.
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11 Nov 2006, 14:19
And for these purposes a SEP should be the same as any old IRA. SIMPLE-IRAs have different rules but SEPs should be the same.
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11 Nov 2006, 16:03
Mark, thanks a lot!

Fidelity That's where my money is collecting handsome interest.
I definitely need to do some reseach on this to make best use of the little money I have in the 401K. (about 1yr's tuition)
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11 Nov 2006, 21:05
Tough call always... taxable distribution, reduction in potential of your money to make money, the money is currently tax defered. If I didn't have alot of debt from college I don't think I'd do it... but of course that is a situation that is very, very individual.
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12 Nov 2006, 10:49
I would not do it unless the amount you have in there is minimal
I wouldn't play with my retirement money unless you have credit card debt
Otherwise, the interest gained in the account ( if you are aggressive) will outweight the interest rate on any loans
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12 Nov 2006, 14:47
Since the federal govt. subsidizes at least part of the loan package for most students it probably makes more sense to borrow at this subsidized rate and leave the 401(k) account alone. For CC debt, investigate your refi options.

For what it is worth (not much), this is technically an exception, and not an exemption.

The difference in treatment between a 401(k) and IRA with regard to education expenses is a dangerous trap for the unwary as discussed in the Domanico case below. In the Domanico case, the taxpayer mistakenly believed that 401(k) plans were excepted from 10% additional tax in accordance with the provisions of IRC Section 72(t). The US Tax Court found that the taxpayer was indeed obligated to pay the 10% additional tax.

http://www.ustaxcourt.gov/InOpHistoric/ ... um.WPD.pdf
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12 Nov 2006, 15:22
Thats an interesting case. The ruling seems to come down mostly to timing. She tried to offset a 2001 distribution with educational expenses for subsequent years and the court found that the exemption only applied to the year of distribution. That does make sense. Her 401k is not the typical case in that one is forced to take immediate distribution or roll. In most 401ks (at least most Fidelity 401ks) you don't have to take a full distribution all at once or roll. I've seen a few but it isn't all that common. Most you are in the clear if you have over 5000, a typical de minimus amount. But certainly if you were in her situation you should have rolled to an IRA and taken distributions as need in THE SAME YEARS AS YOU INCURRED THE EDUCATION EXPENSES. Thats interesting though Hjort, I'll read the rest of it later... Cool case.
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12 Nov 2006, 18:14
What the heck... are all your guys accountants or something!! ?
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12 Nov 2006, 20:18
If I'm reading the PDF correctly, this woman took money from a 401k because she bought a book at borders that said she could - not because she actually read any tax laws --, got told she couldn't because a 401k is a qualified retirement plan and not subject to the exception, but IRAs would be only because of the technical difference between the two?
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12 Nov 2006, 21:07
A 401k is a qualified retirement plan... I'll read the whole thing later but it seems like her problem came in that she had to take a full distribution or rollover. She took that full distribution but the higher ed expenses where not in the year she took the distribution but rather in subsequent years. You can't claim an exemption for future years. You get an exemption for the year of the distribution. Her argument seems to be that she was forced to take a full distribution so she had no choice but to do it that year and because she had to take a full distribution rather than partials she should get the exemption. Thats stupid because you can roll it over and take the money as needed.

Going to school in 2007...
Roll over 401k or keep in 401k if you can take partials...
Take some in 2007 for 2007 expenses and claim the exemption if it was all used in 2007.
2008 take some more for 2008 expenses and again take the exemption for the 2008 expenses... blah, blah...

Not take it all in 2007 and say "well I'm gonna use it for higher ed in the next 2 yrs so I will exempt the amount I expect to use" Wrong. Doesn't work like that. You need to match the distribution year to the expense year.

The IRS doesn't play games and doesn't let you play games either. Unless the law says you can do it I would never come up with "my own creative approach." The IRS doesn't deal in creative approaches. You do things their way or you are screwed.
12 Nov 2006, 21:07

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