Don’t Make This Mistake with Your 401(k)

With regard to medical problems, it is often said that an ounce of prevention is worth a pound of cure. The same is also true of financial planning; by anticipating and preparing for future expenses, you can often avoid money problems down the road.

This lesson is certainly true where your 401(k) is concerned. One of the biggest mistakes people make with their retirement accounts is taking early withdrawals. Parents often make this mistake because they’re desperate to provide their children with a college education. It’s a worthwhile goal, but one that can really backfire if you make mistakes in funding it.

Since the average cost of a four-year college degree these days is $59,800, it’s easy to see why parents often go to extremes to pay the tuition bill. Adding to the problem is the fact that the cost of tuition has increased at a rate of two and a half times the inflation rate in the past three decades! This means parents who set aside funds for college years ago may still find themselves stunned at the price tag on a college tuition today.

And yet, withdrawing the needed money from your 401(k) is usually not the best plan. Yes, it can take you years to pay yourself back. But an even bigger problem is the lost compounding interest that would have accumulated in your account during that time.

Look at it this way: There are other ways to pay for college, such as grants, scholarships, loans, work study opportunities, and so on. But once you reach retirement, no one will be offering you a grant or loan to pay your living expenses! The best plan to cover college tuition for your children involves planning ahead years in advance, and setting aside money in a 529 savings plan with all taxes deferred. If you find you still haven’t saved enough, consult with your school’s financial aid department. Just avoid raiding your retirement account when there are so many options to pay for college, because you’ll likely make a permanent dent in your savings from which it’s very difficult to recover.

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