Should You Use Your Retirement Fund to Pay Off Credit Card Debt?
Published by admin on March 17, 2010
Should You Use Your Retirement Fund to Pay Off Credit Card Debt?
There is little chance that you will ever take out a loan that charges interest anywhere near that on credit cards. Credit cards are the worst kind of debt that you can possibly have, not only do the come with very high interest rates but they don’t provide an asset that increases in value like the house your mortgage bought does. The best thing you can do for your financial well being is to get your credit cards paid off as fast as you possibly can. Even if this means taking out a new loan it is usually a good idea since you can almost certainly get a better interest rate.
One option for paying off your credit card debt is to borrow money from your retirement fund. Usually you can borrow up to half the money in your 401K account and use that money to pay off your credit cards. Not only is the interest rate much lower, but you are really paying it to yourself. Any interest that you pay will go straight back into your 401K account. In most cases this is a good way to pay off your credit card debt but it isn’t the perfect solution. There are some things that you will need to take into consideration.
The biggest downside to using your 401K to pay off your credit cards is that you are effectively being taxed twice. Because you are already received the tax deduction when you initially contributed you can’t claim it again when you pay back the loan. This means that you are paying the loan back with after tax dollars, when you retire and withdraw the money you will be taxed again. This is a major downside to using your 401K to pay off your credit cards, you may want to talk to an accountant to determine whether or not it is a good idea, it can be quite complicated.
The other big downside is that you have limited time to pay back the loan or you will suffer some pretty stiff penalties. You have to pay back the loan before you retire, it also has to be paid back within five years, most problematically it has to be paid back before you leave your current job. This means that if you get laid off you are basically getting a double whammy, not only did you lose your job but you now have penalties attached to your retirement fund. Any money that isn’t paid off before you leave your job or within five years will be treated as a distribution and taxed based on your current income levels. Even worse if you are under sixty there will be an additional tax penalty for early withdrawal. If you are at all in doubt that you won’t be able to pay back the loan in five years or before leaving your job it probably isn’t a good idea to borrow from your 401K to pay off your credit card debt.
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