Save and Invest

Rand Paul's new bill would let Americans pay off student loan debt with 401(k), IRA savings. Here's what that means

Twenty20

Sen. Rand Paul, R-Ky., recently introduced a new bill that would allow students and parents to withdraw retirement funds to pay for college or repay their student loans. But experts say that might create more financial problems than it solves.

The Higher Education Loan Payment and Enhanced Retirement Act, or HELPER Act, introduced by Paul this week, would allow Americans to take out up to $5,250 from a 401(k) or IRA tax- and penalty-free each year to pay for college or make monthly student loan payments. Individuals can also take out funds for educational expenses for spouses or dependents.

That means if two parents each have retirement accounts, they could withdraw over $10,000 cumulatively each year to pay for their child or dependent's education. And while an 18-year-old might not have a 401(k), it is possible they could take funds out of a Roth or traditional IRA if they set one up and worked during high school.

Americans owe more than $1.6 trillion in student loan debt, and the price of college continues to increase each year.

Should you draw from retirement to pay for college?

Criticism of the bill ignited online, with many individuals pointing out that most Americans are already struggling to save enough for retirement. Some 22% of Americans have less than $5,000 in retirement savings, according to Northwestern Mutual's 2019 Planning & Progress Study. Just 5% have between $5,000 and $24,999 saved, while only 16% have saved $200,000 or more. The Federal Reserve recently reported that 25% of U.S. adults have no retirement savings at all.

VIDEO1:3401:34
Suze Orman: Why you should never pay student loans from your 401(k)

Student loans are a big part of why many adults aren't already saving for retirement. By the time they reach 30, those with education debt have half as much saved as those without, according to the Center for Retirement Research at Boston College.

What's more, financial experts typically advise parents not to use funds from their 401(k)s or IRAs to pay for their child's college costs, and individuals not to take from their own retirement. While you can borrow money for college, there isn't the same option to fund retirement.

Using retirement savings to pay for college could be a "slippery slope" and create a bigger financial issue in the long term, Jeannette Bajalia, president of Petros Financial, tells CNBC Make It. She says 401(k) balances are already "too low" for many people to enjoy a "successful" retirement.

[I'm] not sure what the value is to having legislation deal with the student debt issue at a time when we're trying to raise awareness that the parents of college-age kids are not saving enough for their own retirements.
Jeannette Bajalia
Petros Financial

"People are living longer, and the statistics of the elderly poor are growing, particularly with longevity in women," says Bajalia. "[I'm] not sure what the value is to having legislation deal with the student debt issue at a time when we're trying to raise awareness that the parents of college-age kids are not saving enough for their own retirements."

One benefit of the plan, though, is that if you are not currently maxing out your retirement account contributions, you could increase your savings to match the debt or tuition payments you're already making, allowing you to save on the costs overall thanks to the tax break, Denise Nostrom, certified financial advisor and owner of Diversified Financial Solutions, tells CNBC Make It.

This would be helpful to graduates right out of school, who have time to recoup any potential lost contributions to their retirements.

"It's going to give them a little impetus to put money in a 401(k) and then be able to use that money to pay down these loans, which will help them pay the loans down quicker and then focus on retirement," says Nostrom. "You get a little more bang for your buck because it's pretax dollars."

It's going to give them a little impetus to put money in a 401(k) and then be able to use that money to pay down these loans.
Denise Nostrom
Diversified Financial Solutions

Still, Mark Zandi, chief economist at Moody's Analytics, told the Associated Press the bill is not necessarily a boon for graduates with debt.

"I don't think it provides any meaningful relief to distressed student loan borrowers," Zandi said. "They're already behind the financial eight ball."

Improving student loan repayment assistance

The bill would also allow employer-sponsored student loan repayment plans to be tax-free up to $5,250 per year and repeal the cap on the student loan interest deduction, which currently starts phasing out once your modified adjusted gross income reaches $57,000 per year.

That's a potential bright spot in the bill, considering nearly nine out of 10 recent graduates with student loans look for employers offering student loan repayment assistance, according to a survey of around 2,600 U.S. adults by Abbott, a health-care company.

Democratic presidential candidates are also offering a variety of policy proposals to address the student loan crisis. Former Vice President Joe Biden and Sen. Amy Klobuchar, D-Minn., are proposing two tuition-free years of community college, while Sens. Bernie Sanders, I-Vt., and Elizabeth Warren, D-Mass., have proposed that public universities be tuition-free and student loan debt be forgiven.

Don't miss: Elizabeth Warren's $1.25 trillion education plan aims to end the cycle of student debt—here's how

Like this story? Subscribe to CNBC Make It on YouTube!

VIDEO2:1602:16
Why Ramit Sethi says student loans 'can be a great investment'
make it

Stay in the loop

Sign Up

About Us

Learn More

Follow Us

CNBC.COM