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.

There have been many great comebacks throughout history. Jesus was dead but then came back as an all-powerful God-Zombie.
 

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.

 
Best Response
Edmundo Braverman:
^^^ 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.
Just wanted to correct this for anyone who might stumble on it. You can pull money out of a pre-tax IRA (converted from a 401k) for college tuition and it will be a qualifying distribution. Furthermore, if your education does not qualify you for a new industry and is done either temporarily (one year or less) or part-time, you get to deduct it as a business expense.

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%.

 

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