While I’m generally against using retirement funds for anything but retirement, it’s not uncommon for people to quit their job and go back to school. And a common source of funds for this sort of endeavor is… Yep, you guessed it… Retirement accounts. As it turns out, though, not all retirement accounts are created equally when it comes to making withdrawals for various non-retirement related expenditures. For example, you can make penalty free withdrawals from an IRA for eligible education expenditures or for a first-time home purchase (although the latter is subject to a $10, 000 lifetime limit).
The problem is that these same sorts of withdrawals are subject to a 10% penalty (plus applicable taxes) when you’re dealing with a 401(k). Granted, you can always take a loan from your 401(k) to get around the penalties, but the loan will likely come due immediately if you quit your job or get fired and, if you can’t pay it all back at once, the outstanding amount will be subject to the same penalties you were trying to avoid in the first place.
Another thing to watch out for is that, even if you opt to make the withdrawals from an IRA, you could face penalties if you pull out more in a given year than you actually spend. So if you’re going back to school for, say, two years, don’t pull the full amount all at once. Rather, spread it across the years or you’ll get nicked for the 10% penalty on whatever you don’t spend in the first year.
Oh, and one last thing… If you leave your job, you can always roll your 401(k) into an IRA, at which point you’re free to take advantage of the comparatively generous IRA withdrawal rules. Again, I’d personally avoid tapping my retirement funds if at all possible. But if you have to do it, make sure you’re smart about how you go about it.