Generally, it is considered a bad idea to take money out of a retirement account to pay off debt, particularly if you must pay early withdrawal fees
Dear Let’s Talk Credit,
Should I take out $13,000 from my 401(k) account ($30,000), which isn’t earning any interest, to pay off two credit cards? I am 69 1/2 and work part time. I continue to put $1,300 every month in another 401(k) account that earns 10 cents on the dollar. I’m thinking of doing this after the first of the year. I hate the thought of doing this but also hate the thought of paying interest (or balance transfer fees). I also receive Social Security and have a pension. — Mary
Generally, it is considered a bad idea to take money out of a retirement account to pay off debt, particularly if you must pay early withdrawal fees (under the age of 59 1/2). At your age you would not have to pay early withdrawal fees, but you would be wise to consider several things before you remove any money from your retirement savings.
First, are you able to make your monthly payments and are you making progress on paying down your credit card balances? For $13,000 of debt, at an interest rate of 12 percent, you could pay off the debt in three years, if you make monthly payments of $432. In total, you would pay $2,545 in interest charges. If your interest rate is 12 percent or higher, transferring the balances to a 0 percent card could save you money, even with balance transfer fees.
Second, you will have to pay income taxes on the amount you withdraw from your 401(k) account. At an income tax rate of 25 percent, you would pay $3,250 in taxes and would need to remove $16,325 from your 401(k) if you need the full $13,000 to pay off your balances. If you have already considered the income taxes in what needs to be withdrawn, you will pay $2,600 in taxes to pay off $10,400 in credit card balances. You can play out different payoff scenarios using the “Credit Card Payoff Calculator.”
Third, do you have enough money saved for retirement that you can afford to withdraw $13,000? You are still working now, but what if you were unable to keep working? You might not be able to continue adding money to your retirement accounts if you could not continue working.
I would encourage you to take a look at where your money is invested in the 401(k) account from which you are considering withdrawing funds. If you don’t have one already, you might consider visiting with a financial planner to help you determine the best investment strategy for your retirement accounts.
Lastly, I hope that you have a spending plan in place so that you will not need to add to your credit card balances. Getting out of credit card debt is a great goal for anyone, but especially for those entering their retirement years. Once you begin living on a fixed income, the less debt you have, the better.
Let’s keep talking!
See related:Keeping your credit score high in retirement