Cashing Out 401(k) To Pay Off Credit Card Debt?

A reader writes in with an interesting scenario:

I’m 28 years old and I have two 401(k) accounts, both with about $30,000 in them. At the same time, I have about $25,000 in credit card debt because I made some very stupid moves a few years ago. I’m paying this debt down, but it’s at a snail’s pace – I have played some balance transfer games, but I still keep getting hit with finance charges. Even if I never charge another cent, I calculate that I won’t be able to pay off this tremendous debt until 2011. I have my financial life in order now and I’m spending much less than I bring in each month.

I am considering using one of the 401(k)s to pay off debt. Even after the tax penalties, my calculations show me that I’ll get about $21,000 out of one of them, leaving me with a little under $4,000 in credit card debt which I could eliminate by the end of the summer.

Should she do this? There are a few factors to consider here.

First of all, she’s 28 years old, meaning that she’ll be paying into a 401(k) for a few decades before she will retire. Given that she still has $30K in a 401(k) indicates that she’s putting a pretty heavy amount into them each month. While this move will obviously hinder retirement, it isn’t a complete disaster.

Second, that amount of credit card debt is a serious weight. She’s pretty clearly committed to paying it off the right way without damaging her credit any more than it already has been, which means that she’s going to have a long road ahead to get it all paid off. If she’s accruing finance charges on even some of it, it’s going to be very difficult to make significant forward progress on the debt without some sort of significant change in the situation.

Third, she’s looking at four years of intense debt repayment to dig out of her hole. That’s not easy, and to pull it off she’s going to have to have a very solid period of time in her life. If she loses her job or another significant event occurs, she could be in very significant trouble.

In the end, I find that this is one of those numbers versus emotions issues. You can draw up all sorts of models out of this scenario and many of them will say that she loses money in the long run by doing this. I tried plugging in some salary and 401(k) estimates and I found time and time again that looking at this situation from age sixty-five, even with conservative investment growth, it looks like a bad financial decision purely based on the numbers.

Yet I still think she should make this move. Without making it, she will be beholden to a significant debt over the next several years that is going to limit her choices and her opportunities in life. What if the perfect job came along for her, but she couldn’t take it because it meant an initial reduction in salary? She might pass up opportunities for love, for children, for many other things because of the burden of debt – it influences your mindset and decision making in countless ways. She’s 28 years old, she would still have $30K in retirement, and would be much closer to being debt free with this move.

Any additional advice here is more than welcome!

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  1. chazzman2000 says:

    I wouldn’t touch the 401k for anything. Why not curb future 401k investments until the debt is paid off? Do you have anything that you could sell? Do you have anything that you could cut back on? Could you get a second job?

    The $25k credit card debt has to have more of a story to it. There would be a very good chance that she could fall back into her old ways.

    If she could find ways to get some extra $$$, it should take less than 4 years. Even if it did take 4 years it isn’t that long. If it was a long time why would people ever go to college? You will be kicking yourself when you retire if you do this…

  2. OldAndBroke says:

    I question if she did the tax calculations correctly. 30% seems kinda low. Did she calculate both state and federal taxes?

    I would vote for stopping new contributions to any 401k and work at paying off the debt. Leave the 401k alone.

  3. bk says:

    I agree with chazz. I wouldnt touch the 401k. The future value of that 30K at 10%/yr till age 65 is 1 million, without any more contributions. I would just stop making contributions altogether instead of paying the huge tax and penalties (although, myself, I would still contribute up to the match still).

  4. kim says:

    Do not touch the 401K!!!!!! Get a part time job, a room mate, even move in with mom and dad before messing with retirement. The thing that was not mentioned here is that simply spending the 401K doesn’t teach you the dicipline to not use the cards again. The reader seems to be viewing the 401K more like found money than hard earned investment!

  5. cjf says:

    Leave the 401k alone, I agree with the others, lower the contributions and use the money to pay the debt quicker. Secondly, has she looked into getting a loan (at a much lower interest rate) to pay off all or part of the debt?

  6. noma says:

    Very interesting dilemma. The 401K is one of those things that has become a kind of holy grail of personal finance. Yet Trent advocates dumping some of it at this time.

    I think he’s right on point when he says it’s one of those emotions v. numbers issues. Maybe some of the reactions speak to the emotional impact of touching a 401K.

    The focus on the preserving the 401K is financially sound, but I think there are definitely elements that don’t translate into dollars and cents. The writer may find that it is very stressful to have debt.

    There is also a living for the moment v. living for today issue at hand. Obviously we want to plan for the future. But what if global events, a war, a famine, climatic change, preclude any of us from collecting on our ‘rightful’ 401Ks.

    All this planning is focussed on events far, far into the future which we can’t possibly predict. Without getting too cosmic, I think one could argue that they are, in some sense, illusions!

    This is not the same line of argument as live for the moment (grasshopper v. ant) and don’t worry about the future. But it does come down to quality of life and what one values most.

    Financial models are not life. They are tools that we use to help us make decisions. Hopefully, we take other things into consideration, too.

    I think to rule out cashing out a 401K is understandable, but leans a little too hard on the future at the expense of the present.

  7. MVP says:

    Trent, I must disagree with you on this one, my man. This woman said she can pay off $4K by the end of summer!! Multiply that by four to equal a year, and that tells me she has the potential to pay off roughly $16K in a single year. Why then does she anticipate having to pay off the debt until 2011? Doesn’t make sense to me. Without knowing her income, I can only say it’s taken my husband and me only about 18 mos. to pay off about $40K on about $72K annual household income. Granted, we’re a couple, and I’m assuming this woman’s single, unless I’m missing something, she could have this paid off within a couple years by taking extra jobs, selling stuff, getting a roomate, becoming more frugal, or myriad other ways. Don’t liquidate the 401K, but DO stop paying into it, and any other investments, until the debt is paid off, and she’ll be good as gold (as long as she gets rid of the cards and learns to handle her finances better going forward, which I’m sure she will). Also, how do you know she’ll be paying into the 401K for a few more decades? She may decide to become a stay-at-home mom, or she may become disabled or laid off at some point and not be able to work and contribute to the 401K. Who knows? Anything’s possible.

  8. tehnyit says:

    I have to agree with MVP. She is only 28, and the FV of her 401k at her retirement age would really set her up.

    Obviously, she is making great headway into her 401k, so she could divert the money going into her 401k into her credit card payments.

    I hope that she has burned her credit cards and never to touch it again until the debt has been cleared ;-)

  9. Chris V says:

    I’d say, it could go either way depending on the variables.

    First, she should call up the credit card companies and see if they can lower their interest rates.

    Once that occurs, if those credit card rates are more than 10-12%, which is more than the average the stock market goes up in a year, then paying off the credit cards would be a good idea. Otherwise, she’d be losing more in credit card interest than she’d be making in 401k interest. And, her net worth would decrease.

    On the other hand, if those credit card rates are less than 10-12%, it MAY be to her benefit to not pay them off. She COULD make greater 401k interest than what she’d lose in credit card interest. But, 401k returns are fickle. Just because things have gone great over the last few years does not mean they will continue.

    Lastly, I should mention that the stock market could plummet tomorrow, devastating her 401k account, but still leaving the credit card debt. Depending on her tolerance for risk, she may not want that to happen. She should weigh her concerns there against her young age, which gives her more time to recover from problems.

  10. Larry Deane says:

    I agree with the others, don’t use the 401k. Most likely there is more than just tax penalties, a number of employers charge an early withdrawl penalty on top of the tax penalty. With the company I work for, I can’t even pull the money out until after I leave.

    I would stop contributing and apply the contributions to paying off her debt and do anything else required, including getting a second job.

  11. PJ says:

    I’d say don’t touch the 401k… but perhaps cut your regular contribution to it in half – the other half going to the ccard. Also, a debt consolidation loan or similar instrument may be able to 1) lower the interest rate on the debt and 2) turn it into a regular monthly payment with a known term – like a car payment or student loan. I find that having a fixed term spelled out 1) gives me something to look forward to, and 2) I learn how long such spending will continue to cost me if I ever even THINK about doing it again.

  12. Jen says:

    If I were her, I wouldn’t pull anything out of the retirement funds. Instead I would (actually, I did this!) reduce my contributions to the match until I got out of debt. If I wasn’t happy with how that affected my payoff timetable, I would even consider stopping all contributions until the CC debt was paid…but I would NOT take that money out of the 401k.

    Ever.

    One of the things that is definitely going to help keep me out of debt is the pain I felt while paying that monster off…If we stay on our plan, we’ll be debt free by the end of the year…exactly 2 years into our “get serious” plan. If I had taken what I needed out of my 401k to pay off the debt 2 years ago, I would have more debt now. I think the pain of paying it off slow just does something to a person that helps ward off making the same mistakes again.

    But that’s just me. ;-)

  13. chazzman2000 says:

    If her credit cards were higher than 10-12%, I’d still wouldn’t touch the 401k.

    The taxes and penalties on the 401k withdrawl fees would be around 35-45%. That would give her about $19,500 at best to $16,500…not the 21k given in the article. Even if you went with article’s estimate that is a 30% rate you just paid to get money.

    She shouldn’t be too worried about the stock market crashing and devistating her account. Why? Because she is 28 and shouldn’t be in it until many decades have passed. If the stock market doesn’t rebound at all, then we’ve got bigger fish to fry.

  14. Lisa says:

    Taking money from a 401K should only be done in an extreme emergency. Using it as a way to pay off debt due to “stupid moves” a few years ago is not an emergency. Pay off the credit cards slowly but surely. Or, do as the others suggest and get a 2nd job, sell things, take in a roommate to pay it off earlier. The feeling of accomplishment after it is done will be tremendous. You’ll also become accustomed to living well below your income. With that habit, after the debt is paid off, you can save for a vacation, contribute more to an IRA/401k, enlarge your emergency fund, buy a car with cash and the list goes on. So you don’t feel totally deprived use your raises, COLA, tax refunds ect to vacation or endulge yourself several times a year. Best wish!

  15. Kristina says:

    This is terrible advice. Any money taken out of retirement ends up losing at least 40% of it’s value — a 10% penalty plus the full tax rate. This is not worth it, and is even worse than credit card rates. GET AN EXTRA JOB!!! It’s insane to pay off $25,000 so slowly. An extra job is worth not pulling retirement money out of good investments and worth the compound effect of leaving your retirement alone. Go clean some houses on the weekends, delivery pizza at night, get a part-time job at UPS or the mall, babysit, or do some consulting on the side if you have a specialty area.

  16. Ron says:

    I have to throw in with the majority. Leave the 401k alone and start delivering pizzas. Paying that debt over four years is painful but not as much as the loss to her future retirement.

    If she could go four years ahead in time, what would she like to see? The debt paid for and $100,000 in retirement or no debt but much less in retirement savings for the future?

    Once you do anything negative to your retirement savings (stop contributing, withdrawl, etc) you never ever make it back.

    Ron

  17. Trent says:

    My estimation, based on her numbers, is that she is very low income right now – that’s why the 401(k) penalty and taxes only added up to that relatively low amount. Given the credit card mistakes she mentioned and also the rather large amount she had in a 401(k) at a young age leads me to believe that she made a major lifestyle change and career shift recently that she’s not mentioning – probably the result of a quarterlife crisis when she realized that her career track and chase of consumerism wasn’t leaving her fulfilled.

    If that’s all true, she likely IS living very tightly right now and she’s also not going to have nearly as high of a standard of living in retirement.

    Hopefully, she’ll speak up on this comment thread – often people with interesting stories like this do eventually pop in.

  18. David says:

    I think she should tap into the 401K and pay off the credit card debt, but only if she is committed to being debt-free going forward. She is young enough, and without the credit card debt, will have the cash flow to get her 401k balance back up where it was through increased withholding.

    Unless she’s able to take a lump sum distribution of the 401k from a former employer’s plan, her current plan will probably not allow her to take a hardship withdrawal to pay off the debt anyway.

    Her employer may offer the option of taking out a 401K loan, which uses the 401K balance as collateral. You are usually limited to borrowing 50% of the current vested balance or $50K, whichever is lower. There’s no 10% IRS penalty for early withdrawal, or any tax payment, in this scenario, and she will be converting her high interest credit card debt into a low interest loan to herself. All her payments, withheld biweekly from her paycheck, to principal and interest, will go right back into her 401k, with the benefit of dollar-cost averaging. If there’s a major correction during the term of the 401K loan (e.g. the market pulls back significantly from the recent all-time highs), she might even end up essentially shorting her mutual fund holdings to her advantage. However, the payments will be made with after-tax dollars, and should she leave or lose her current job, the loan would have to be paid off immediately.

    $25K in credit card debt is not going to be paid off in four years by delivering pizzas on the side, or by scrimping and saving (if there’s nothing left to cut back on). Very unlikely the market will provide a better rate of return (historically 11% on average) than the interest on the debt (which, if not already there, will jump to 18-25% if she so much as misses one payment). This is a soul-crushing burden that needs to be resolved ASAP. If not by tapping into the 401K, then by filing for bankruptcy. Extreme situations require extreme measures.

  19. Rxforfinance says:

    I would combine the 401(k)’s into her current employers. If that one allows loans, I would then take out a $25k loan to pay off the credit cards. Usually loans can be modeled to be paid off in 1 to 4 years directly from your pay. Worst case if you quit or get laid off your loan would be considered a distribution, but no worse than liquidating it now. These cards should be cut up, if they haven’t been already.
    This way you are acutally paying yourself back with interest instead of the CC. If you can continue your current contributions into the 401(k) even better. If you cannot affored the loan repayment and current contributions, then contribute to the company match, if there is one.

  20. Engineer says:

    Maybe she’s in a low tax bracket right now. But if she pulls out $30K from a tax-deferred retirement fund in one year, she’ll be pushed into a higher tax bracket, at least 25% or perhaps even 28% federal. Add on the 10% penalty and state income taxes and her net after withdrawal will be closer to $15K.

    I agree with others. Better to stop future 401k contributions for a year or two until the balance is a bit more manageable. Just don’t forget to restart your contributions.

  21. Patrick says:

    David and Rxforfinance bring up a good point: Borrowing from her 401k may be better than cashing part of it out. I know a few people who have done this in an emergency situation. You lose out on growth, but you don’t pay the early withdrawal fees and taxes, and you pay yourself back.

    Another good option is to stop paying into the 401k (or pay only enough to get the employer match), and use that money to pay down her cards.

    The only way I would tap my 401k, is as Trent mentioned, the debt is too much to bear and is limiting her options or future quality of life.

    Without knowing more about her situation, it is tough to offer the best course of action. The most important thing is to commit to a new way of life and stop using the credit cards immediately.

  22. MVP says:

    David said: “$25K in credit card debt is not going to be paid off in four years by delivering pizzas on the side, or by scrimping and saving…This is a soul-crushing burden that needs to be resolved ASAP. If not by tapping into the 401K, then by filing for bankruptcy. Extreme situations require extreme measures.”

    Wow, this just isn’t true. If a person is dedicated to getting out of debt, there’s no limit to the things they can do to help themselves – yes, extreme situations call for extreme measures. But bankruptcy?! Gimme a break! This woman simply needs to put her nose to the grindstone and work to get out of the debt she created. It IS possible – millions of us have done it and are better for it afterward.

  23. Jim Lippard says:

    Why does she have two 401Ks? The main benefit of the 401K is the employer match on new contributions; once you leave the company you’re generally better off rolling it over into an IRA so that you have more investment options, unless you had really good options already in your 401K.

    I agree with those who suggest borrowing against the 401K (if possible) rather than taking early distributions and penalties.

  24. Hector says:

    Take it out and pay off that 25K and please tell her to NEVER ever use a credit, don’t even have any! credit cards are for weak people.

    YES there are penalties and taxes but interest rate on 25k worth at an average 14% interest is way worse than say 28% one time fee

  25. TheLocoMono says:

    Touching your 401k erodes your power of compounding. The best thing to do is take a deep breath, listen to the different recommendations and find the ones you are more comfortable with and explore it further. You can easily keep your contribution to a minimum in order to recieve free money from your employer.

    It will raise your take home income and taxes but not by much if you remember the tax bracket you are in. Research your tax bracket and find out if ou move into the next tax bracket by meeting the minimum. If you don’t then it is clear that you are just spending the same amount of taxes as you do in your current bracket.

    If you really want to pay down your credit card in the quickest amount of time, then you need to track your expenses, find out where your checking account is leaking money. Once you find out, then make a commitment to stop that right away.

    By combining the increased take home income with the extra cash you found by patching up your leaky checking account, you should be able to pay down extra money on your credit card sooner than later. There are a few different schools of thought how to pay it off but its math. Look at your credit card bills and figure out which one you would save more in interest if you pay it off with the most principal down.

  26. Beth says:

    She could look at it this way: even if it takes her four whole years to pay off the debt, she’ll be 32. Her 60-year-old self is going to thank her profusely for keeping her retirement accounts intact.

    I’d say, try as hard as humanly possible to pay off the debt, and revisit the question in a year. By then she’ll have a better idea of the time line and the quality of life, and can then see if she wants to tap a 401(k) to pay it off.

  27. Sharon says:

    I agree with the “do everything for a year and see where you get theory”.
    Tell ourself that you will get a roommate and a second job and eat out only on a limited basis. (get a second job where they feed you!!).
    And then when you look at it in a year, realize that you can cut back if you need to…fewer hours at the second job, maybe just work at seasonal work in the summer and Christmas.
    And then look at taking out a loan from the 401k’s. At my job, they don’t look at your credit report, just process the loan. (If I wanted a “hardship withdraw” I would have to have it approved.) So the cashing out may not even be possible.
    I realize someone might be able to raise $4000 over a summer by superhuman efforts, but if you try to find some “extra” human efforts for a year or so, you might have a clearer idea of how much you really need.

    Sharon

  28. bearhead says:

    She should totally do it. I was in the exact same situation a few years ago, and I don’t regret for a moment cashing out my 401(k). The key, of course, is to never, EVER, pay interest again for anything that doesn’t have a front door and a roof attached to it.

    Her 401(k) does not exist in a vacuum; she needs to think about her overall financial health. The debt could very well be costing 18% interest (not to mention fees), which even with an aggressive monthly payment of $500 will still cost her over $4000 in the first year. She should cash out her $30K 401(k) now, pay off the debt, and then immediately start putting the amount she was previously spending on interest into a Roth IRA. Or if she prefers, defer that money to expenses and increase her 401(k) contribution to help alleviate the increased taxable income.

    Keep that up for a few years and she’s back where she started.

    Why pay money to the interest demons? Make it work for you, not against you. Do that and you’ll be amazed at what options become available. Ever since I paid off my debt, I’ve been able to put more than 5x as much into savings as I was previously. After just a few years, I’m almost back to where I was before cashing out, and give me another few years of increasing contributions and compounding interest to blow away where I would have been had I still been paying down my debt and saving a pittance.

    And to you nay-sayers out there furiously guarding your 401(k) — My 60yo self will be buying me a beer, while your 60yo self will be using 401(k) dividends to finish off that student loan you’ve been paying the minimum on for 40 years.

  29. The Landlord says:

    I don’t think you understand the implications of how cashing out a 401k works. trust me, I did it a couple of years ago to use that money to buy some real estate. It’s not pretty.

    the first thing that happens is that you take an immediate penalty of 10% for breaking the rules. Then the money is taxed as regular income at the end of the year. Let’s say she’s currently earning $29,000 a year and paying 25% on that. Her income for 2007 would be considered $59,000 and she’d be paying 28% on the $30k she withdrew.

    By this calculation, she’ll have paid more than 35% of her 401k to penalties and taxes, costing her more than $10k.

    While a credit card is dead weight, certainly it’s not 35% dead weight. Cashing out your retirement is typically a foolish thing to do. The numbers don’t add up.

  30. maxconfus says:

    /leave the 401Ks alone
    /close cc’s
    /renegotiate cc interest rate
    /calc payment for term of 36 mos
    /learn more about pf over next 36 mos than any book, blog, or relative can tell you…
    /it worked for me @ 8 yrs ago

  31. Kevin says:

    The woman should definitely consider bankruptcy as an option. Whether or not it is viable is for a bankruptcy attorney to advise and recommend.

    The advice will depend upon more information than we have been given here. In some jurisdictions, retirement accounts will be left untouched by a bankruptcy filing. Additionally, her credit would start repairing within 2yrs after filing chapter 7, which could be better than the 4-6 year payment schedule. Even a chapter 13 will only require a 5yr. plan, so that might be something to think about, as well.

    Good luck!

  32. bearhead says:

    I very much understand the implications, as I did it myself. I still recommend it for her situation, fully. Your situation is different because you were cashing out your 401(k) to *increase* your debt. That’s not just “foolish”, it’s outright nutty. You basically suckered yourself into buying something you couldn’t afford (if you could have afforded it, you wouldn’t have needed to cash out your 401(k)).

    Like I said, look at your financial state as a whole, not a series of parts. Don’t spend money on interest if you don’t have to.

    Sure, cashing out a $30K 401(k) will incur a 10% hit. However, the tax you pay on the resulting increased income is null, because you pay now or you pay later. And you have absolutely no idea where you will be at 60, what the tax laws will be, what the market will look like. Hey, you might even be a billionaire. How silly would you then feel about those prime years between 28 and 32 when you ate like a college student so you could pay an extra $200 on stupid credit card debt?

    If you’re young, you can make up the difference in no time. Just by not spending the $300 or so a month in interest gives you $300 more to stash away.

    Personally, I’d rather pay $3000 now than spend approx. $9500 in interest paying off a $25K loan at 15% for the next 54 months. Life’s too short for $700 monthly payments on something as soul-crushing as credit card debt. Ask yourself this — would you write out a check to your cc company for $9500 for the privilege of paying them monthly installments for the next 5 years? That’s what you’re telling this young lady to do.

    Nope. Cash out. Take the hit. Pay off the debt. Then furiously build your 401(k) back up. It’s so much easier to be motivated when you see those numbers going UP rather than DOWN.

  33. Amy Haden says:

    I can speak from personal experience on this one as I took a loan from my 401K to pay off a small credit card debt in my early 20′s (I’ve never had credit card debt since), and then I cleaned all but $1,000 out of my 401K as a deposit on my first (and only) house in my late 20′s. I do wince a bit when I look at my 401K balance and realize it’s about half what it could/should be (I’m 42 years old now), but I simply wouldn’t have a house otherwise. So even though I’ll probably never have what I could’ve in my 401K, I’m very satisfied with my decisions.

  34. Camille says:

    I can also speak from personal experience… I cashed out some retirement when I left a job (at 28), used it to pay off debt, then got even deeper into debt. Leave the 401(K) alone!!

    I would suggest credit counseling, looking into a roommate, second job, serious budget, cutting back on contributions and redirecting funds to pay off debt, anything but touching a retirement account if one hasn’t dealt with the issues that led to the debt. Will the questioner be in better shape in 4, 5, 10 years if he/she still has the same habits that got him/her here in the first place?

    So what if it takes 4 years to pay off the debt? It will help the poster learn better money management skills (we hope) along the way, and if not, at least he/she will still have a retirement fund.

  35. I wouldn’t touch the 401K with the penalties. I’d continue to “play the balance transfer games” while paying off the debt the best you can during the game. If you tighten up your strategy with this, you should be able to avoid finance charges or at least keep them to a minimum. With that being the case, there’s no downside in paying down the debt without cashing out the 401K plan.

  36. Pingback: Carnival of Debt Reduction
  37. Amit says:

    Pay her debt using 401k but commit herself to invest the money she will be saving by not making minimum payments every month.And, continue to pay her 401k as usual.

  38. Brian says:

    What if I cash out my $30K at age 40? I see the point about life being too short and not knowing what the future holds as making more sense than not ever having debt paid off and not enjoying my 40′s. At this age, I do not want to be stressed out on bills and missing career opportunities as a result of debt. Retirement = waiting around to die. I plan to live and continue contributing to society at a ripe old age. This does not mean I can’t rebuild my 401K and other retirement funds after age 40.

  39. createnj says:

    I agree with bearhead; she should cash out the 401K, accept that she will have to pay a possible penalty and taxes, and move on. Then she should proceed to put money back into her 401K. There is no need in being a slave to a job just to pay bills. I am taking an early retirement (obviously older than she is) and plan to do the same thing with my 401K, then I will be able to take the job of my choice, put money into my 401K, and relieve myself of the miserable job that I am in now.

  40. Chris says:

    I am going through the same thing right now. I have a new job and I am contributing the full amount to my 401K. I will be taking 20k out of my old employers 401K to pay down all debt. The penalty is huge, 30%min. But there are no options. The cc companies will not negotiate with someone who is making only the min. payments. why would they. they are making a killing off of me at 17.9% on $18,000 debt. I save, work 2 jobs have cut up all but my Corporate card that I use for work travel. Debt consoildation for a $20,000 loan would cost me $5,400 over 96 months. Do you really thing my 401k will earm 5,400 over the next 96 months. Not only that but I will have in excess of $600/month to but back into my 401K and savings plans. At 37 years old I feel I did the only thing possible. Get out of debt now, stay out of debt and max out all savings. The future is much brighter today than it was a month ago. Take the money now, pay the penalty, and never pay interest again. I am on the road to finacial freedom, sure a few dollars short in the long run but I’ll make it up with contributions to my savings not the creidt card companies Profit line!

  41. Allen says:

    I agree with the two posters that suggested a 401k loan. I have used the loan process three times myself, each time paying off the balance and interest to myself. I only have one credit card with a balance on it, but I do have a line of credit with almost $5000 in medical bills (my wife is now one year cancer free!). When I complete the current 401k loan, I will consolidate the medical bills and the one remaining credit card into one 401k loan and pay myself the interest!!!

  42. Cj says:

    Ah-h-h!! I am staggered by the lack of basic financial understanding I see in the posts. A few get it, many do not. For those of you that say “I took out of my 401k and it was just great”, well, that doesn’t make it right and misery loves company. As a financial advisor, I have to clean up these messes and work with individuals to re-tool a plan for living in retirement. Furthermore, it’s wonderful on a blog to suggest she not use credit cards again; however, human nature is she will cards again and will end up in the same situation.

    Don’t ever use a 401k to pay for consumer debt. This is basic principal of compound interest. And to those of you who ask “..so I can’t fund a retirement plan after age 40?” Well, hold on to your hats, you can, but you have lost so much ground, you better be ready for a very frugal retirement.

    It appears she can pay off the cards as MVP suggested. Since she is young, she will receive the “magic” of compound growth in her retirement account. If she has to dig her way out for several years, so be it. It’s a good lesson and a good test to her claimed enlightenment of seeing her past foolish spending. An easy way out seldom teaches any lessons. Retirement is coming, it can be a soft breeze, or a train running a full speed. Which one hits you in the face is up to the financial decisions and choices you make.

    Sorry to sound harsh, but I see the results of bad financial moves on a regular basis.

  43. jv says:

    my too pennies.

    If you decide to take it out, combine and do loan. Whatever part of that loan you can’t pay back because of lost job, take out needed portion from remainder to pay tax man. The longer you can hold onto your job, the less penalty you will need to pay.

    Generally, don’t touch 401, if you must, just be prepared for penalty. Do what you need to do. All other number are predictions and are worthless.

    Don’t stop match contribution. It can be up to an instant free 8 years of interest. If not vested, or extra, forget it. Income now. Save later, before age 40 is good enough.

  44. Caleb says:

    Let’s first address the biggest loss of money, the future value of this account. Let’s say you don’t add another dollar to that account, you retire at age 65, and your account grows at 10% (this is reasonable given your age), you would have $1,020,118 in that account.

    Now looking at the current cost, your 401k provider will w/hold 20% ($6,000) and send that to Uncle Sam, and you are responsible for a penalty of 10% ($3,000). Think about that $3,000 though. You pay that b/c you didn’t play by the rules. This money is earmarked for retirement, not temporary problems. Based on how much you’ve socked away in your retirement and how much you’ve racked up on your credit cards already, you probably make a healthy income. So this additional 30k is going to affect your tax situation, so 20% is probably not going to be enough, so you may pay more.

    The old fashioned way of paying down the debt over time is your BEST bet. You have such a great retirement started, you would be robbing yourself of a really nice retirement. I think it is HORRIBLE advice to cash out. However, if you make less than $30,000/year and your budget is tight, and you really don’t have much to put into your credit card debt…..go for it, cash out.

    Remember that $1,020,118 mistake when you are 65 though.

  45. Sck says:

    I agree with the logic to never cash out 401(k); but found myself in a situation where an illness forced my wife out of work for an extended period, during which we racked up nearly 45K worth of rotating debt (other considerations should have been made during that time, but you can’t go back in time). Unfortunately the compound interest on those cards also applies to the debt you have, of which much of mine was growing at a rate of 16% +. So when figuring out how much you make in retirement savings, you have to subtract how much debt you cannot resolve.

    Having two children, being 39 instead of 29 (as the questioner was) and seeing my marriage quickly desolving I made the decision to take that amount out of my retirement fund and pay off our tremendous revolving debt. It was to simply allow us to face a future with a monthly budget in the black; which even at minimum payments was not happening.

    I’m not proud of what we did, but I want to post here just to let people know that we did the math on the difference between our 12-21% compounding interest on cards and our compound interest gain of saving that money for another 25 years (average 10%). Remember, the debt is accruing interest on interest also. We also had to take into account the severe penalties of withdrawal. From a mathematical standpoint, it still didn’t look like a good idea; but from a standpoint of getting back my family I made the decision.

    I agree with most of the posts in that this is a last, last resort. We did it when we were on our last straw, and I can say I do not regret it. I am not proud of it, but do not regret it. My marriage, family life and career have all taken upswings which I do contribute some of to the fact that I’m not throwing up every night, wondering how I can make ends meet this month. Contrary to most people that do this, we haven’t ever charged another cent. At 40, retirement is much closer, and while our life has changed, the comfort came at a tremendous price. But worth it.

  46. Greg says:

    No one can say with certainty that this is bad or a good move. There are simply too many variables and assumptions.

    If the 401k is being completely neglected in order to pay off credit card, it might not be a bad move, particularly if there is a company match on the 401k.

    Assuming she can withdrawal enough to satisfy all of her debt (probably not likely, but for illustrative purposes), she’d likely need to withdrawal about $38.5k (25% tax and 10% penalty), leaving her with $21.5k.

    Using the four-year timeframe, her portfolio, if left untouched while yielding a 7% return, would be worth just under $80k.

    However, assuming the credit card debt carries an average interest rate of 15%, it would require a monthly payment of $695 to satisfy that debt in four years.

    If that $695 was then diverted to the 401k, she’d have about $67k at the end of four years, based on a 7% return. In other words, her net worth would be about $13k less than if the 401k was untouched. Obviously, it would be better to suck it up for four years and climb out of the hole.

    However, if there’s a company match – say 50% of the first six percent, that would be another $173.75 per month that could be contributed, bringing the monthly contribution to $868.75. Over four years, at the same 7% return, the value would then be over $76k.

    For many, that $3k trade-off might not be so bad, in and of itself. Once you add in the prospective tax benefit of contributing into the 401k, she may in fact come out ahead at the end of year four if those tax savings are further invested.

    Of course, that’s just for illustrative purposes. She may not have any company match or she may already be contributing the maximum, her credit card rates could be lower, etc…

    In summary, though, I think it’s worth evaluating if you have a 401k plan with a company match and you are entirely neglecting your 401k.

    If you are already contributing to your 401k, but not enough to max out the company match, it may still be worth evaluating, but the benefit will not be as great.

    Conversely, other than immediate satisfaction/peace of mind of eliminating the credit card debt, it is significantly less justifiable – if not simply foolish – if no company match is available and/or you are already contributing enough to max out the company match.

    And, obviously, withdrawing from the 401k to pay off the credit card debt and NOT rerouting those monthly savings into a 401k or other investment account is quite possibly the worst financial decision someone could make.

  47. Niece says:

    I think she should go ahead and use the $ from her 401K. I was laid off from my job, while my husbands company started demoting and scaling back on salaries. That was my rainy day, my future. I am married with children and a home. Apart from the unemployment of $500 every 2 weeks
    and my husbands reduced salary. I still had to pay bills. The only thing that kept me afloat was using my credit card in order to pay my taxes etc. For those who can afford not to touch that 401K, bravo,but as a single women, she has 2 401K’S which is better more than most.

  48. gma says:

    I too am thinking about withdrawing my 401K to pay off massive debts. For a period of a few years, due to many circumstances, I wasn’t even looking at my debt load, and recently it was like I woke up and a actually saw how bad it it. Right now the stress level is so high, that I may not even make it to retirement, which for me is less than 20 years away ~ and sometimes desperate times call for desparate measures…

  49. Sck says:

    I posted earlier, as an individual that did cash out. My one suggestion would be to meet with your tax advisor prior to doing this, and to also meet with a credit counselor. My family life is much better since paying off the debt; but I am now reserving 12% of my salary to my 401K to make up for some of the lost assets. The tax implications are hefty; as was posted here. I would definitely meet with your tax advisor so you don’t end up in a bad place with the government being owed.

    As I said before; I don’t suggest this as anything but a last effort. Getting input from professionals is definitely worth doing beforehand. I don’t regret doing it; but don’t suggest it either.

  50. Troy says:

    Too many people use emotion for part of their reasoning, yet simple math and numbers for the other part.

    Aside from the 10% penalty, whether you use money to build toward retirement or pay off debt is determined by emotion…what makes you most comfortable.

    That really should be it. People say “but you need money in retirement due to compounding” or “you will never get that time to invest back” or “the miracle of compunding interest”

    It isn’t a miracle, it is mathematics, and it applies to DEBTS as well as assets. Paying off a high interest debt mathmatically accomplishes the exact same thing as investing money at the same interest rate.

    However, paying off the debt achieves a guaranteed rate of return, usually with lessened risk. It also usually makes people less stressed.

    Also, disregard the taxes. You have to pay taxes on any money you use to pay off debt, whether it is from a qualified retirement plan, or from your own income.

    So, you come back to the penalty for early withdrawal. Calcualte the penalty amount, and ask yourself if spending that amount of money is worth having the debt retired. Proceed accordingly

  51. jamie says:

    Wonder what that 401k looks like today after the big market drop? I’d have used the 1/2 to pay off the debt and felt better about life in these extremely shaky times.

  52. steve says:

    “Paying off a high interest debt mathmatically accomplishes the exact same thing as investing money at the same interest rate.”

    I disagree-as a rule of thumb, it doesn’t equal the same thing when you are comparing a taxable investment to a debt, but not when you compare a tax-advantaged 401(K) with paying off a debt. The debt has a shorter lifespan. When you cash out funds in the 401(k), you are losing not just the 3 years of interest, you are losing all of the tax-free compounding on that sum until retirement. That is leaving aside the penalty.

    Really, to decide these situations you can use a rule of thumb like this as a guideline, but you really need to pull out your spreadsheet and put together comparative scenarios and project them forward 40 years. That’s the way I prefer, in the end, to get answers to such questions so I can make informed decisions.

    As regards jamie’s comment as to whether cashing out a 401(k) last year before it dropped 35% would have been a lucky move or not–yes, it would have. But that would have been due to luck, and you can’t account for that.

  53. steve says:

    It’s interesting to me that she wrote “Even if I never charge another cent, I calculate that I won’t be able to pay off this tremendous debt until 2011.”

    I am surprised she would even be considering charging another cent, given the situation she has put herself in. Maybe she was just being loose with her writing, but I would think in her situation she would be writing, “even thoughI have stopped charging and am planning NOT to charge another cent.”

    I think Trent has an interesting point about how having debt can alter your outlook and how that could have a bad effect on a person in their late 20s. But then again, isn’t pulling out the cash from the 410(k)really just putting a “happy fix” on the situation? If in fact it is leaving you in a less advantaged position financially, you want to be thinking about resetting your emotions if possible. You should see if you can start feeling good about doing the “financially correct” thing, rather than choosing something suboptimal because it “feels” better and will restore “quality of life” (translation: make you feel that you are more flush so you can go ahead and enjoy a higher standard of living/consumption) To me, that’s just a signal that you need to recalibrate on reality. Facing up to the fact that it’s going to take 3 years’ worth of payments to kill that debt will be worth it in the end. Because after that 3 years, you could apply those payments to other goals.

    I would also say, if you are getting hit with late charges (it’s not clear if she means this when she says “finance charges) on your cc debts, it MIGHT be worth while to take enough out of your 401(k) to give yourself the cushion to stop that happening.

  54. G says:

    DO IT! Take the penalties and DO IT. Let me show you what diligent investing does for you…

    I started saving for retirement in 1984. I was always taught the value of saving when I was a child. I saved until it hurt. I scrimped every single penny I could to save for what I hoped for an early retirement. I changed jobs, rolled my 401(k) into the IRA and kept going. My latest 401(k) is the same. I save until I run out of money each month. You know where it all is now?! GONE. I had it primarily in mutual funds and it’s back down to 1988 levels since 1/1/08. I’ve lost literally hundreds of thousands of dollars. So I cashed it all out and I’m starting to live life and blowing money like the rest of America.

    It doesn’t pay to save. Blow it and have fun. I wish I would have taken that advice in 1988…I would be in the exact same spot I am today.

  55. Ann says:

    I ditto the post above–saved and scrimped until it hurt and now our 401K has dropped from over 1M down to approx. 600K. On top of that, my engineer husband with a masters degree and 20ys experience was laid off for 3.5 yrs back in 2001-2003 and we wound up with about 25K in cc debt left over from that fiasco. I wasn’t worried about it as we still had alot of stock outside of our 401K that we could liqidate to pay it off and the cc’s were all at extremely low interest rates. When my husband finally found a fulltime job again, I decided to start a business and bought a real estate franchise–great timing right. I was doing fine and breaking after the first year and moving towards profitability when the bottom fell out. We also have 4 kids and two are in college–all said we are now in debt to the tune of about 80K and like everyone else–I’m worried about husband getting laid off again as he is now being required to take 25-30% cut in pay every month due to the economy–he works at a very large corporation. Because of occassinal missed cc payments–the interest rates have shot up to 18-25% and our credit is terrible now because of the high amount that we owe and the lates. We are thinking of liquidating part of our 401K to pay them off. I really don’t want to do this but we have to get back to the black every month if we can. Oh–and I already did a 401K loan so thats not an option–took it out to help buy out a partner that didn’t want to be involved in the business any longer and that payment is very large every month as it all has to be paid back in 5 years. We have always saved between 20-30% of our pay every month since we were in our early 20′s and we are now in our mid 40′s so I’m not worried about being able to save. We have about 7 more years and all 4 of our kids will be finished with college(one graduated this month) and then our savings rate should be very high and hopefully–my real estate company will have taken off by that time. Even with the market downturn, we have about 350K equity in our home but still owe 300K but we can’t get a home equity due to the credit issues now. Same for refinance and we have a low interest rate so I wouldn’t want to refi any way. After riding the markets thru the 87 downturn, the 2000 and 2001 downturn and now this downturn–I just really don’t think an 8-10% verage return is reasonable–I think it should be more like 4-5%. I think it pays to save but if you are worried constantly about cc companies calling you–its not worth it. We didn’t waste any money on vacations, eating out, etc. so I don’t feel bad about the credit I have accumulated but I do want to pay it off and stop the rediculous interest charges on the cc’s.

  56. nel says:

    [] We lack discipline, financial education and don’t have a clue on how to handle media marketers…that helps us get into this mess.

    [] Once we say we have had enough, none of your numbers make sense to someone going through rehab…but a fresh start is priceless.

    [] Cash the 401k in, pay the debt, freedom that no one owns you…what is this result worth?

  57. Utah Lawyer says:

    I cashed out this week. I am a lawyer making good money (over 150k a year). I am the only breadwinner in the family. My spouse stays home with the two kids who are both in diapers. I lost my job but luckily got a new one almost immediately. The new job only pays $110k base pay with bonuses paid out quarterly. Sadly, we are burdened with about 80k in medical debt (we had really bad insurance for a few years and no insurance with some surgeries and chronic illnesses). I don’t want to file bankruptcy b/c it negatively affects my ability to be employed and be appointed to office etc. So, we pay every dime to pay our bills each month. Literally, we make it down to $1.00 on some money and others I have to take cash advances from the bank to make our bills. This is at the $150k rate of pay. So, by taking the new job–we seriously were going to be in debt to the tune of $1500 per month! We were going to be on the street (not to mention stressed, unhappy and scared)… I had $38k in one 401k account and I cashed out. I kept 20% in the account to cover taxes for early withdrawal. I am scared about what the tax implications beyond this initial $7500 is going to be…but I was on medical disability for 6 weeks this year (and made less) and hope that the lesser pay at the new job, this reduction in income and the fact that I have lots of tax write offs will “work it out.” WIth $30k to pay down some of the debt—we got our head above water. We will still be living pay check to paycheck—but we can live off the $110k salary and when I get the bonuses each quarter–we can pay down the debt even more.
    I think that each person’s situation is so specific that it is hard to know what this woman should do. For me–I was boxed in by debt–not wanting to file bankruptcy and saw this as a way to make this new job work. Also–the new job has the opportunity to make me more money in the long run–I also have a better employer contribution to the 401k at the new place (10% rather than 4% at the old job) so I hope that I will save more aggressively at the new job (once I get over the 1 year probationary period) and make up for the lost money quickly. I also have better health insurance and hopefully the chronic medical issues facing myself and my kids–won’t rule our lives from here forward (don’t lie to your self–paying the maximum out of pocket of $15k per family for years and years–really adds up!). So–I say–if you have not other choices–do it (and don’t regret it b/c you can’t change the past) but if you have other options exhaust them. Good luck!

  58. Utah Lawyer says:

    I cashed out this week. I am a lawyer making good money (over 150k a year). I am the only breadwinner in the family. My spouse stays home with the two kids who are both in diapers. I lost my job but luckily got a new one almost immediately. The new job only pays $110k base pay with bonuses paid out quarterly. Sadly, we are burdened with about 80k in medical debt (we had really bad insurance for a few years and no insurance with some surgeries and chronic illnesses). I don’t want to file bankruptcy b/c it negatively affects my ability to be employed and be appointed to office etc. So, we pay every dime to pay our bills each month. Literally, we make it down to $1.00 on some money and others I have to take cash advances from the bank to make our bills. This is at the $150k rate of pay. So, by taking the new job–we seriously were going to be in debt to the tune of $1500 per month! We were going to be on the street (not to mention stressed, unhappy and scared)… I had $38k in one 401k account and I cashed out. I kept 20% in the account to cover taxes for early withdrawal. I am scared about what the tax implications beyond this initial $7500 is going to be…but I was on medical disability for 6 weeks this year (and made less) and hope that the lesser pay at the new job, this reduction in income and the fact that I have lots of tax write offs will “work it out.” WIth $30k to pay down some of the debt—we got our head above water. We will still be living pay check to paycheck—but we can live off the $110k salary and when I get the bonuses each quarter–we can pay down the debt even more.
    I think that each person’s situation is so specific that it is hard to know what this woman should do. For me–I was boxed in by debt–not wanting to file bankruptcy and saw this as a way to make this new job work. Also–the new job has the opportunity to make me more money in the long run–I also have a better employer contribution to the 401k at the new place (10% rather than 4% at the old job) so I hope that I will save more aggressively at the new job (once I get over the 1 year probationary period) and make up for the lost money quickly. I also have better health insurance and hopefully the chronic medical issues facing myself and my kids–won’t rule our lives from here forward (don’t lie to your self–paying the maximum out of pocket of $15k per family for years and years–really adds up!). So–I say–if you have not other choices–do it (and don’t regret it b/c you can’t change the past) but if you have other options exhaust them. Good luck!

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