Why pulling from a 401(k) to clear student loans may backfire

Legislation passed in 2022, the SECURE 2.0 Act, permits employers to contribute to employees' retirement accounts when they make qualified student-loan payments, yet fewer than two percent of plans have adopted the feature. Robert Farrington, founder of The College Investor, stresses that taking money out of a 401(k) before age 59.5 typically triggers a 10% early-withdrawal penalty plus federal and possibly state income taxes, and eliminates the benefit of compound growth.

While Roth contributions can be withdrawn tax-free, earnings and traditional balances are still penalized, and hardship withdrawals are not allowed for loan repayment. Borrowing against a 401(k) avoids taxes but requires repayment with interest and can become due immediately upon job loss, turning into a taxable distribution if defaulted. Given these costs, borrowers are urged to consider income-driven repayment plans, the new Repayment Assistance Plan that forgives debt after 30 years, or public-service forgiveness programs rather than depleting retirement assets.