If layoff looms, don't touch your 401(k) plan money
You may need that retirement nest egg now, but too many things can go wrong
By Gary Foreman
The New Frugal You
Dear New Frugal You,
My wife and I have about $30,000 in credit card debt. There
is a good chance I may be laid off soon, since my company just got bought out.
Should I take out a loan against my 401(k) to pay off the debt? I just turned
50 if that matters. -- Rick
I'm sorry to hear about your potential job loss. Given your age and debt situation you need to
take the threat seriously and begin taking action now to prevent big problems
The picture isn't pretty. According to an Urban Institute report, older workers (age 50 to 61) who were laid
off took more than nine months to find a new job and when they found one, their
earnings declined by 23 percent. So losing your job is likely to be a financial
Debts are a major stress point if you do lose your job. I'd strongly advise against borrowing from your 401(k). Generally, you'd be
required to repay any 401(k) loans within a month or two of losing your job.
Completely. Not on a payment plan, but the whole loan.
If you can't repay the loan, it's canceled. That's not good news. The payments that would have replenished
your 401(k) plan won't be there. So you'll have less when you retire in a few
years. And, to make it even worse, that loan will
be considered an early distribution. You'll pay a penalty and the amount will
be added to your taxable income this year. Ouch!
So let's see if we can't create a better plan than a 401(k)
loan. Ideally, we'd like to find find ways to keep you current on your bills
and not deplete savings until you can find a new job.
You're absolutely right to focus on the debt. Paying for
past spending when you're surviving on severance or unemployment benefits can
be tough. So anything that you can do now to pay off any money you owe is a good idea while the paychecks are still rolling
in -- even if that means cramping
your lifestyle now.
It's unlikely that you'll be able to repay $30,000 in the
next few months just by reducing expenses. So consider ways to reduce the cost
of the loan -- that is, its interest rate.
Credit card debt is usually fairly expensive. That's because
it's only backed up by your word and your ability to repay it. Unlike your
mortgage or car loan, where the lender has a way to get some or all of their
money back if you're unable to repay, if you break your word and fail to repay
a credit card, the lender has nothing to seize.
So the obvious thing would be to see if you can borrow
against your home or auto at a rate lower than what you're paying on your
credit cards. If you can get a lower-cost home or auto loan, use the money to
pay down the credit cards. More of your monthly payments will then be going to
reduce principal. Borrowing against a home or car also means you're trading a
variable rate loan -- the credit card -- for a fixed-rate loan.
If you can't borrow against your home/auto, the next step
would be to see if you qualify to transfer a balance to a lower-rate credit
card. You didn't mention your FICO score, but if
yours is high, that's good:
It opens more low-cost options for you.
The other tool you have to reduce the amount you owe is to
stop using your credit cards. Every time you pull out plastic you put yourself
further from your goal.
I'd suggest that you take a hard look at your spending
habits. Fewer than half of all families have any credit card debt, and only
about 15 percent of credit card holders have a balance greater than $10,000.
A $30,000 balance should be a warning sign. A flashing one. Neon red.
If that credit card balance isn't due to a family financial
crisis, it's time to recognize you're living beyond your means. If you continue
to do so, you'll end up in credit counseling or bankruptcy regardless of your
Speaking of your job, there's an old saying that you might
want to take to heart. It's easier to find a job while you have a job. If you
really feel that your job is in danger, begin the search for a new position
now. Fair or not, many employers will favor someone who's working over someone
who has lost a job.
You're wise to size up potential danger. Sure, it's tempting
to look the other way and hope things turn out OK. But by taking action now you
can put yourself in a better position to avoid a layoff in a new job or
minimize the damage if you do lose your job.
See related: Preparing for a layoff, Taking out a 401(k) loan? Be ready to repay if you lose your job, Laid off and in debt: 5 steps to take now
For more than 35 years, Gary Foreman has worked to help people get the most for their money. Prior to founding The Dollar Stretcher.com, he was a financial planner and purchasing manager. Gary began The Dollar Stretcher website and newsletters in April 1996. Today the website features more than 6,000 articles on different ways to live better for less. Gary has been interviewed by The Wall Street Journal, The Nightly Business Report, USA Today, Reader's Digest and other newspapers and magazines. Gary answers a question about a budgeting or saving issue from a CreditCards.com reader each week.
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Published: July 5, 2012