08 Jul Best way to pay off college debt

Q. I need another $30,000 to pay my son’s remaining college bills. I don’t have the cash. Am I better off with a home equity loan (my home is almost paid off) or should I take a loan from my 401(k) plan? I don’t plan to retire for another 10 years.
— Dad

A. We’re glad you’re thinking long and hard rather than making a quick decision.

The choice you make can have long-term consequences for your finances.

In the past, when people needed money to pay off debt, they would go and use their home equity to do so, said Bill Connington of Connington Wealth Management in Paramus.

He said the rates were usually low and payments could be stretched out over any number of years.

However, with the drop in prices in homes due to the housing selloff in 2008, the amount of equity in homes was reduced, Connington said.

That is when investors started borrowing from their 401(k)s, he said, calling it the new place to go for funds.

“In 2011, the IRS collected 5.7 billion in penalties from individuals taking early withdrawals from their 401(k) plans,” Connington said. “Borrowing from your 401(k) may cause you to affect your retirement savings, pay fees for the loan as well as interest, your take home pay will be reduced and some plans will suspend contributions until the loan is paid off.”

And if you lose or leave your job before the loan is paid off, you may need to pay off  the balance. If you can’t do that, the loan may become a premature withdrawal.

Connington said if you have to choose between the two, you should first determine the interest rate you’d pay on the home equity. You can deduct that interest on your tax return. Then see if that rate is lower than the 401(k) loan.

But you should also step back and ask yourself why you’re taking full responsibility for your son’s college costs.

If your son is out of college and working, Connington asks if it might be prudent for him to take on the responsibility of his education or even helping to pay a certain amount each month to paying for these costs.

Conning said you should consider having your financial advisor or accountant calculate which is the best approach so you can make a good financial decision for your future.

“In paying for your child’s education, you have helped them with theirs, but how will this affect the money you need for retirement?” he said. “You say it will be in 10 years but remember when you retire you will need your assets and Social Security to maintain the lifestyle in retirement that you have worked towards.”

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This post was first published in July 2016.