I'm in my 30s with $30,000 in a 403(b). I'm facing a $20,000 college-tuition bill. Do I raid my retirement account or take out a student loan?

By Alessandra Malito

'I don't have any student debt, and I'm worried about the interest rate'

Dear MarketWatch,

I'm in my early 30s and I have $30,000 in a 403(b). Saving for retirement has always been a priority, but paying for the day-to-day expenses has kept me from putting more money away for the future.

I'm looking to go back to school, but the total cost would be $20,000 ($5,000 required every six months). I'm not sure if I should take a graduate loan, which would most likely be unsubsidized, or if I should take a hardship distribution or loan.

I don't have any student debt, and I'm worried about the interest rate if I were to take out a graduate loan. I'll still be working throughout this extra education, and school will begin in April.

What should I do?

Have a question about your own retirement savings? Email us at HelpMeRetire@marketwatch.com.

Dear Reader,

Going back to school can be a really rewarding endeavor, but saving for retirement while keeping up with everyday expenses isn't easy, even for the most seasoned budgeter, and there are times in life when it feels difficult to do both. That said, it is possible to accomplish your goals.

Raiding your retirement account for a non-emergency - even for something as important as education - is typically frowned upon, especially if it's a distribution and not a loan. Withdrawing such a large chunk from your 403(b) robs you of the potential investment returns you'd otherwise get if you left the money alone. You also have to pay taxes and penalties for an early distribution, which would eat into your retirement savings even more.

Let's start with the student-loan option. An unsubsidized loan is obviously not ideal, since interest begins when you're in school, but you do have options.

Federal loans are available to graduates or professional students, up to $20,500 per year. These loans have a fixed rate, but flexible repayment plans, which is better than the other way around. The current fixed interest rate is 7.05% for direct unsubsidized loans, according to Federal Student Aid.

To get a federal student loan, submit a FAFSA form (short for Free Application for Federal Student Aid).

You don't need to go the federal-loan route, but if you decide you'd rather take out a private loan, proceed with caution and shop around. They tend to be more expensive than federal loans, and they're not quite as flexible, warns the Consumer Finance Protection Bureau.

"Your private loan interest rate and monthly payment could change with little warning, and you will have fewer options for when and how much you repay," the agency says. Also, try to conduct all of your credit inquiries within a two-week window, since multiple inquiries over a longer period of time can affect your credit score.

If you're taking an unsubsidized loan, aim to begin debt repayments right away to avoid interest accruing while you're learning. Look at your budget, and if you don't have one, analyze your current cash flow instead. This doesn't have to be an arduous process - simply look at all of the money you have coming in and going out every month for, say, the last two months or so, and see if you have extra money every month to put toward a student loan. If not, can you make any adjustments to the way you spend? The worst-case scenario would be that you put no money toward the loan until you graduate, in which case you'll have a larger balance to pay off.

Retirement-plan options

Now on to your retirement-plan options. A retirement-plan loan would probably be the first preference, even over a student loan, said Daniel Galli, a certified financial planner and principal of Daniel J. Galli & Associates, but there are caveats. First, this is assuming you can make the payments within five years, so that you avoid any taxes or penalties. Also - and this is a big one - you may be required to pay the loan back in full if you were to leave your place of employment, so check with your human-resources department to see what the rules are for your particular plan. Sometimes you can only pay back a retirement-plan loan in full or via the monthly payment (meaning you can't put extra money like a tax refund towards the loan to lower the balance). Again, make sure you know what the terms are.

The loan would also be limited to half of your vested funds (or $50,000, whichever is less), so in your case you could take out a $15,000 loan and have a $5,000 shortfall to make up for, said Carol Fabbri, a certified financial planner and executive director of the Fair Advisors Institute, a financial-literacy organization. You do pay interest on retirement-plan loans, but it goes back into your own account. If you were to go this route, you could then take a student loan for the remaining $5,000, Fabbri said.

"She will still have money in her 403(b), so she won't be starting from nothing when she begins saving for retirement again," Fabbri said. "The downside is that she will have to pay the loan back in five years, including the time she is in school. This could put a lot of pressure on her."

The hardship distribution is a last resort, Galli said. "If she has no or low income, this may be an option but otherwise, I'd avoid it," he said.

It might help you to do a cost analysis of the straight distribution. For example, figure out what the interest rate would be on your student loan, and calculate what you'd ultimately pay in interest if you were to follow a specific repayment schedule. Then look at your retirement account - if you use a relatively conservative 5% rate of return over the same period, what could you potentially get if you kept the money where it is?

Let's take this example. If you have $30,000 in your 403(b) with a 5% rate of return and no additional contributions over the next five years, you're looking at about an $8,000 return at the end of that time period (in other words, $8,000 potentially lost, not including what you paid in taxes and penalties). Comparatively, if you take a $20,000 student loan for a five-year term with an interest rate of 7.05%, and assuming payments begin immediately, the total amount of interest is a little less than $4,000. Those figures can change, based on market volatility, the interest rate and terms of your loan and the amount you pay every month toward your loan, among other variable factors.

"The argument often made is that the return you are earning within the account needs to be more than the student-loan payment to make financial sense to take a loan," said Crystal McKeon, a certified financial planner and chief compliance officer at TSA Wealth Management. "However, I think the right attitude to take is any money in a retirement account is reserved for retirement unless you have some drastic situation."

In short, the decision is of course entirely yours as to how you pay for your education, but try to think of the long-term impact of your decision. The good news: Going back to school is a great way to improve yourself, and it could help you make more money and pay yourself and your future.

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-Alessandra Malito

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02-21-24 0949ET

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