I am about to change jobs, I am 24 and have a little bit more than my current student loan debt saved in a retirement account. Once I leave my current employer, I basically get free reign over my retirement money. I have two options (basically): First, roll that into what my new employer will provide or use it to pay off my student loans. My student loans are at 6% fixed.

I've ran the numbers and it seems that compound interest is in favor of keeping my retirement in the retirement pool but at the same time, I want to hear the arguments for (or against) using the retirement money to pay off the student loans.

Just to be clear, I am not looking to hear retirement advice (IE put your 401k into a roth ira, etc) but rather I am looking to hear the pros and cons of using my existing retirement money to pay off the loans.

Note: I've looked at the similar questions but none really deal with already having a retirement account. That is to say most are kids fresh out of college asking if they should start saving for retirement now or later (after the loans are paid off)

Update: The retirement savings is pre-tax and there is no penalty/fees apart from income tax for using the retirement money. Also, I never really considered actually cashing out the retirement to do this but I was wondering if I was missing some rationale.

  • What's the average growth of your Retirement account? – Noah May 21 '14 at 20:05
  • @Noah, Honestly, that was difficult to calculate (because the employer matches it) but I have it at around 9% last year. My personally managed roth ira got 15% though. What I see as the issue is compounding interest. I would basically negated the 1.5years I've already been saving (cutting 1.5 out of the end of the retirement account -which is a far greater abs val than the stu loans) – Matt May 21 '14 at 20:09
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    @Matt Your comment answer your question. You're making more money on your retirement savings than you're paying in interest on your loans. As long as you can make the monthly payments, keep saving for retirement. And, if you're eligible to deduct student loan interest from your taxes, don't forget that your effective interest rate on those loans may be lower. – Todd May 21 '14 at 22:12
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    Nobody will give you loan for your retirement. – Joe Strazzere May 22 '14 at 12:30
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    @Matt - student loans exist so that students can go to college now, and pay for it later. Unlike almost everything else, you must pay for your retirement before you use it. You cannot get a loan for retirement and pay it off later. Don't shortchange your retirement account. – Joe Strazzere May 23 '14 at 16:43

(Note: The OP does not state whether the employer-sponsored retirement savings are pre-tax or post-tax (such as a Roth 401(k)). The following answer assumes the more common case of a pre-tax plan.)

This is a bad idea, IMHO.

IRS Pub 970 lists exceptions to the 10% early withdrawal penalty for educational expenses. This doesn't include, as far as I can tell, student loan payments. So withdrawing from your retirement account would incur both income tax and penalties. Even if there were an exception, you'd still have to pay income taxes, which, depending on the amount and your income, could be at a higher marginal rate than you are currently paying.

If you really want the debt gone as soon as possible, why not reduce the amount you contribute to the retirement plan (but not below the amount that gets you the maximum employer match) and use that money to increase your monthly payments to the student loan? Note that, if you do this, you will pay taxes on income that would have been tax-deferred in order to save money on interest, so there's still a trade-off.

(One more thing: rather than rolling over to your new company's plan, you could roll over to a self-directed Traditional IRA.)

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    +1 So depending on their tax rate, they will only get 60% - 70% of what is in the 401k the rest goes to Sam. – AbraCadaver May 21 '14 at 21:03
  • The OP didn't detail what they meant by "retirement savings". Depending on what it is, there is not necessarily a penalty; e.g. withdrawing the principal of a Roth IRA. – user102008 May 23 '14 at 2:52
  • @user102008 - True enough, though it does appear to be an employer-sponsored vehicle. I suppose it could be a Roth 401(k), but that seems less likely than a pre-tax plan. I will edit my answer to state that assumption explicitly. – Rick Goldstein May 23 '14 at 4:28
  • Hey, it is pre-tax savings and there is no penalty apart from income tax itself (correct me if I'm wrong), I could deduct the loan payments from my tax return essentially balancing the tax effect. – Matt May 23 '14 at 14:32
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    @Matt - No. If it is a pre-tax plan (like a 401(k)), any distribution to you is subject to income tax plus, if you are less than 59 1/2, a 10% penalty. In fact, you should, if at all possible, completely avoid having the company cut you a check. Even if you roll it over into another qualified plan or IRA within the 60 day limit, they will be required to withhold 20% for taxes, which you will have to get refunded after the rollover. Your best bet is to set up a Traditional IRA with a discount broker, and then arrange a direct rollover from the company plan. – Rick Goldstein May 23 '14 at 15:04

I would advise to never cash out retirement funds unless you're actually retired, or in case of an extreme emergency.

Not only because of the huge tax bill that you'd incur (as @Rick mentioned - in addition to your top bracket rate - add 10%), but also because you will never be able to recover from the loss.

Your current retirement fund is the one that will compound the most. By the time you deposit the same amounts you're thinking of withdrawing now, the compound effect would have grown the original amount further. By the time you could catch up - it would compound further. You will never be able to repair the damage of early withdrawal at this stage.

Consider this calculation (lets say you worked for 10 years out of 40 years of your career path, and have $1K to deposit a year, for ease of computation):

Current value (CV) = $13K
Years to retirement (Yr) = 30
Annual growth (G) = 5%
Additional deposits (Ad) = $1K
Total at retirement (T) = $127K.

Current value (CV) = 0 (you withdraw everything)
Additional deposits (Ad) = $1K 
Annual growth (G) = 5%
Years to retirement (Yr) = 30
Total at retirement (T) =  $69K

Essentially, by withdrawing now, you'll reduce your retirement savings by about 50% in thirty years from now. How much is that 6% interest on your student loan? I seriously doubt its worth it.

  • This is basically what I calculated. It's just difficult for the human element (pay off your debt) to go with logic (best ROI). – Matt May 23 '14 at 14:41
  • This isn't necessarily the case. It probably is when we're talking about student loans (low interest), but it certainly could be worthwhile to cash out retirement savings, pay off a high interest loan, and then put in more money afterwards. As long as the interest rate on the loan is higher than the expected returns on the investment (including taxes), it's worth it. – Brendan Long Dec 18 '14 at 19:14
  • @BrendanLong There's no "put in more money afterwards". Any money that you don't put in now or take out - is lost. You should always put in as much as you can. Don't forget the compounding effect on the returns of the retirement fund, and the tax benefit you're getting. Taking that into account makes paying off debts with this money worth only for very high rate debts, but then - you may be better off with bankruptcy (retirement funds shielded) instead. – littleadv Dec 19 '14 at 2:39
  • I think you're on the right track, but "there's no 'put more in afterwards'" is just wrong. If the interest rate on the loan is higher than the expected return on your investment (taking taxes into account), then it's worthwhile to cash out the investment and pay off the loan. You're trying to make this all-or-nothing when that's not the case. – Brendan Long Dec 19 '14 at 17:50

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