Graduate school and 401K

Hi-

I'm currently a year out of college and working, with the expectation of going to law school or business school within a year or two. I currently save a very healthy portion of my income and would like to know the best way to save money for graduate school. I've already maxed out my IRA, but my major question is should I be putting any money into my 401K? My company does not offer matching funds, but I'm wondering whether the tax-advantage would be worth it (I'm in a much higher tax bracket than I would be as a student). Can I take out money from my 401K penalty free for graduate school only 2-3 years after opening it?

If 401K is not the best way, what are some investment vehicles aside from the IRA which would work well for someone in my position?

Thanks.

I would encourage you to participate in your employer's 401(k). Every dollar you contribute not only builds future retirement savings, it reduces your taxable income. When you leave your job to attend graduate school, you can rollover your 401(k) balance to an IRA.

Normally, money withdrawn from a traditional IRA is subject to both income taxes and a 10% penalty before age 59 1/2. However, money withdrawn to pay college expenses, while still subject to income taxes, escapes the 10% penalty.

An even better deal in your case is to contribute to a Roth IRA. Not only do funds withdrawn from a Roth escape the 10% penalty, you can withdraw your contributions (but not earnings) at any time tax free and penalty free. So if you contributed $3,000 a year to a Roth IRA and after three years, your account was worth $9,600 (earning about 7% a year), you could withdraw up to $9,000--your contribution--tax free and penalty free.

Mary Beth Franklin
Senior Associate Editor
Kiplinger's Personal Finance

Hi,

With regards to your response to ndshah03's question, if one were to rollover their existing 401k balance into a traditional IRA after leaving his or her job and use that amount for graduate school expenses so as to avoid the 10% penalty, would it then be possible to also claim the Lifetime Learning Tax Credit on the IRA distributions, assuming that this person's total taxable income including the IRA withdrawl would be less that $40,000 while in school? If so, it almost seems too good to be true ... !

Thank you!