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Can I Take Out My 401(k) to Pay Off My Student Loan Without a 10 Percent Penalty?

If you're like millions of other recent college graduates, you're barely keeping up with the payments on your student loans. These days, the average college student graduates with over $20,000 in education-related debt. Thanks to a weak economy and a perennially poor job market, millions of well-educated young people are fleeing the "real world" and returning to their childhood bedrooms. If you're one of these unfortunate graduates, you may be looking for a quick escape from your student debts.

If you aren't currently working on a full-time basis, it's unlikely that you'll be able to pay off your student loans through conventional means. While it's possible that you've accumulated a small but meaningful supply of savings over the years, this probably isn't enough to keep you current on your debts. If your long-term post-college employment prospects look bleak, your debts will continue to mount. In all likelihood, you'll either have to return to school or apply for a loan refinancing program. Since both options are likely to have adverse effects on your credit score, you'll need to weigh each of them carefully before deciding which one is best for you.

Of course, the best option is to find gainful employment and begin accumulating stores of long-term savings. Once you've started to pay into a 401(k) plan, your sense of personal financial security will undoubtedly increase. This employer-sponsored fund will serve as an emergency reserve in the event that your debts become overwhelming.

Under normal circumstances, you're prohibited by law from making withdrawals from your 401(k) before you reach the "mandatory" retirement age set by the federal government. If you make an emergency withdrawal before you reach this age, you'll be subject to a 10 percent tax on your total withdrawal amount. For instance, you'll net just $9,000 from a $10,000 initial withdrawal. In addition, you'll also be obligated to pay regular income taxes on the withdrawn amount. Depending upon your specific tax bracket, you could easily lose another 20 to 30 percent of these funds to the IRS.

As such, you should never make an early withdrawal from your 401(k) unless you face a dire financial emergency or qualify for a penalty-tax exemption. Unfortunately, most exemptions exist for taxpayers who incur high levels of debt due to certain specific medical problems. The IRS makes no allowances for early withdrawals related to outstanding student debts. In other words, you may need to learn to live with your student debt unless it's slowly driving you into bankruptcy.


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