Gaming 401k Qualified Distributions for MBA
If I just started as an analyst and plan on attending b-school in 4 years (Sept 2014) does it make sense for me to put everything in traditional 401k and pull everything out to pay for MBA in 2014-2015 (whatever calendar year where my reported income will only be from summer associate internship)?
That way I get 16.5k pretax for 4 years and get those tax savings, and use it to pay down educational expenses in a significantly lower tax bracket.
Does this make sense? What did other anaylsts thinking they were on the ib-pe-mba track do with savings?
Thanks.
Well, the premature distribution will cost you a 10% penalty up front, and then the rest is taxed as regular income for the year you take the distribution. In other words, if you cashed out $50,000 you'd pay a $5,000 penalty and then 28% on the remaining balance (assuming you had no other income because you were in B-school), less any deductions.
Based on that, I'm not sure it's the smartest way to pay for B-school, but it certainly isn't the dumbest either. Where things could really swing in favor of doing it that way is if your employer does any 401k matching that vests rather quickly, or if your 401k performs extraordinarily well over the next 4 years. The penalty and the taxes will be the same, but since you know you're gaming the system the whole time it could potentially represent a greater amount of "free" money, so to speak.
Student loans for students at top professional schools is about as cheap as consumer finance comes. Not sure it makes sense to take that kind of fee load when you could let it continue to compound tax-free.
I second what Edmundo says, find out how much your employer will match and how soon the match vests. The other thing to investigate would be a 529 plan. Contributions are tax-deductible and it is designed for saving for education expenses. I know parents can set them up for their growing children to go to college, but I'm not sure if you can set one up for yourself.
I did something similar to pay for my grad degree. I was in a little different situation since I worked for a small company. My firm was looking to cut cost and terminated our 401K contract with our custodian. We had the option to transfer the funds to a 401K or IRA with a different custodian. I knew I wanted to use some money to pay for grad school so I transfered my funds to an IRA. An early withdrawal from an IRA will avoid that 10% penalty you get hit with when withdrawing from a 401K. You're just then taxed at ordinary income.
^^^ I'm afraid that's not true. Many IRA custodians will give you the option to have them take the 10% penalty out of the distribution up front, but if you decide instead to take the entire amount, you're still on the dangle for the 10% penalty the next year at tax time. In either case, the distribution amount is taxed as regular income for the year it occurred.
Another idea is to take a 401k loan before you quit your job. One downside to this is that most 401k loan provisions only allow a maximum of 50% of the 401k balance to be lent, but the upside is that the payments you make on the loan go back into your 401k, and there's no penalty or income tax incurred by the transaction.
A lot of employers will tell you that you have to pay off your 401k loan before you quit, but that isn't true. Otherwise, what would happen to all the people with 401k loans who get laid off? The fact is, you make the loan payments to the 401k custodian, and they don't give a shit if you're employed or not.
IRS publication 970 has a lot more information on this:
http://www.irs.gov/publications/p970/ch09.html
There are a number of circumstances where you can take out IRA distributions before age 59.5. This includes a one-time $10K withdrawal for buying your first home, qualifying educational expenses, certain disaster-level medical expenses, and taking a "series of substantially equal lifetime distributions":
http://www.irs.gov/publications/p590/ch01.html#en_US_2011_publink100023…
Furthermore, Illinois does not tax retirement income of any kind, including IRA distributions. So if you're going to Northwestern or Chicago for your MBA, you only pay federal tax on the withdrawal. If you are avoiding NYC tax on the distributions, and you drop from the 28% tax bracket to the 15% tax bracket, this works out to a net after-tax savings of about 25%.
401k and Bschool (Originally Posted: 06/02/2010)
Did a search on this but didn't find aanything useful...
Not positive about my bank's 401k matching plan but I have heard some banks match and let you put in 15% of your income. I know that 401k is basically tax-free retirement savings, but you incur a penalty if you withdraw early. So if I plan to save a lot during my analyst stint and put the max into my 401k, will this 'income' count against me if/when I apply to Bschool and need financial aid? If they make me withdraw the retirement savings to finance Bschool is it even worth contributing to the 401k?
Posted this on the Bschool forum as well but thought some others might have some insights.
you should also know most places have a vesting schedule....
typically your not 100% vested out the shoot, it usually goes 30% vested after year 1, 60% vested after year 2, etc etc or some variation similar to that
For B school financial aid (and for most other types of degrees) they will never take into account the money that you have in a 401K (or even other retirement accounts, well ones which you can't withdraw from without penalties anyways.). So, No the money in there won't be considered while calculating the aid package.
Also, if you save money in your 401k, you get to withdraw it penalty-free at likely a much lower tax rate than you were able to deduct when you put it in. In other words, even if you get a $0 company match, it makes sense to take advantage of your 401k plan if you plan on going back to school.
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