A bill introduced this month would allow Americans to use retirement money to pay for college or student loans tax-free.
U.S. Senator Rand Paul introduced the Higher Education Loan Payment and Enhanced Retirement Act to help people cope with the $1.6 trillion student loan problem.
The HELPER Act allows individuals to take up to $5,250 per year from a 401(k) or individual retirement account without paying a tax or penalty. They can put the funds toward the cost of college or to pay back student loans.
Currently withdrawing from a 401(k) or IRA before retirement age incurs a tax penalty. People can only use after-tax money to pay for student loans.
The bill also removes a cap on student loan interest tax deductions.
Generally, it's a bad idea to pull money out of your retirement account. But the bill could help young people who don't have enough cash flow to both pay off student loan debt and save for retirement, said Alexander Vaccarella, senior vice president and financial adviser for the Wealth Enhancement Group in New Jersey.
Instead of paying student loans with after-tax money, individuals could put money into their retirement accounts tax-free, then use that money to pay student loans. The ability to pay for student loans tax-free could make them a more attractive way to cope with debt than 529 accounts, which can't be used to pay student loans without incurring a penalty.
Read our state-by-state guide to 529 plans.
On the other hand, the bill could tempt student debt holders or parents of student debt holders to deplete their retirement accounts.
"If this is a green light from the government to go and raid your retirement to help your children, that can be a bad thing," Vaccarella said.
Retirement funds shouldn't be used for short-term expenses, said Carol Fabbri, a certified financial planner and founder of Fair Advisors. They instead should be invested with a long-term view in mind.
Dipping into those investments undermines any long-term gains. Plus, many people are already behind on their retirement savings.
Planning and having a clear picture of the problem is the first step, Vaccarella said. Your student loan debt may be made up of multiple loans. Vaccarella recommends focusing on those with the highest interest rates.
People who don't have the cash flow to tackle their student loan debt may want to consider income-based repayment plans.
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