topic Re: Revisiting a classic - 401k withdrawal to pay off CC debt in Personal Finance

Revisiting a classic - 401k withdrawal to pay off CC debt

Anonymous — Tue, 10 Apr 2018 22:44:56 GMT

Hello! Hoping someone can help me punch holes in my extremely flawed logic. First, sorry for the long post... I’m very aware of the conventional wisdom on this topic (and the good reasons for it), but I’m wondering if there are circumstances where cashing in a portion of a 401k to eliminate credit card debt is an acceptable solution? For a variety of reasons – some justifiable, some maybe not – my wife and I have accumulated $43k in CC debt. Having lived with this for a number of years now, and felt the enormous weight and pressure it can put on personal finances, we are absolutely committed to never getting here again. Ever. When it’s gone, it stays gone.

For the past few years, we have been trying to aggressively pay down the debt, paying as much as we can monthly, leaving ourselves enough to cover bills, but little else. Our current budget is as pared-down as it can be: no cable, no landline phone, one reasonable car payment, rarely dining out, etc. We are making slow progress, but there are two important issues, as I see it:
1. Without a savings plan, any major expense - car repair, medical expense, house emergency - ends up on a credit card and immediately undoes whatever progress we’ve made.
2. We are perpetually strapped, unable to feel like we are fully participating in life (not taking vacations, rarely visiting family, feeling guilty about any money we spend on ourselves, no matter how small).

Proposed resolution:
I’m aware that this is universally frowned upon, but…
- 401k distribution to cover the entirety of the debt, or,
- 401k distribution to cover about half, and a 0% balance transfer to help us pay the rest down as quickly as possible.

I’m 44, and well aware of the 10% penalty, impact on our income tax liability when filing next year, and what it would do to our retirement bottom line if I withdraw between $30k and $60k. FYI, I’m a little less interested in a 401k loan since it just trades one debt for another, albeit at a lower interest rate which gets paid back to myself.

Why I still think this might be a good idea:
As it relates to my 401k balance at retirement age, I’ve considered three scenarios:
Scenario #1: Don’t touch 401k balance, and continue paying down debt as best we can. Contribute at a rate of 4% (to get full employer match) for the next 5-6 years, then bump contributions to 15%+ once debt-free. Meantime, pray nothing happens that will add to the debt and push the payoff date out further.
Scenario #2: Withdraw $35k from 401k, contribute 4% for the next 2-3 years to focus on paying off remaining CC debt, then bump contribution to 15%+
Scenario #3: Withdraw $60k from 401k, clear all CC debt, and immediately bump contributions to 15%+

Flawed logic time... By my math, using the calculator on Bankrate, the retirement age 401k balance of these three scenarios all end up within about $90k of one another. So am I willing to sacrifice $90k in 20+ years in order to eliminate $42k in credit card debt today? I think I might be. It would instantly change the quality of our lives, freeing up money that could be used to build up a true savings account, comfortably pay bills each month, address the deferred maintenance on our cars or house. Most importantly, it would allow us to take a deep breath and more fully live our lives now.

I keep dreaming of being debt-free, and keep wondering if this would be such a terrible way to do it. What says the community?

Re: Revisiting a classic - 401k withdrawal to pay off CC debt

Anonymous — Wed, 11 Apr 2018 00:27:06 GMT

Even though you have decided against, I would look again at the 401(K) loan option, to see what the interest rate is. A smaller interest rate could make things much easier (although depending on the plan you might have a shorter payback time).

The other thing to consider is a short term impact on taxes. Apart from the 10% penalty, you also have to pay tax on the entire withdrawn amount which is treated as income, which might push you into a higher tax bracket. Whether that matters to you compared to the benefit of being out of debt is for you to decide.

My advice would be to go to a fee only financial planner and get a 1 hour appointment, and let him/her give you their thoughts. It's a fairly big decision, IMO too big to go by consensus on an internet forum.

Re: Revisiting a classic - 401k withdrawal to pay off CC debt

Anonymous — Wed, 11 Apr 2018 02:33:40 GMT

@Anonymous wrote:
Hello! Hoping someone can help me punch holes in my extremely flawed logic. First, sorry for the long post... I’m very aware of the conventional wisdom on this topic (and the good reasons for it), but I’m wondering if there are circumstances where cashing in a portion of a 401k to eliminate credit card debt is an acceptable solution? For a variety of reasons – some justifiable, some maybe not – my wife and I have accumulated $43k in CC debt. Having lived with this for a number of years now, and felt the enormous weight and pressure it can put on personal finances, we are absolutely committed to never getting here again. Ever. When it’s gone, it stays gone.

For the past few years, we have been trying to aggressively pay down the debt, paying as much as we can monthly, leaving ourselves enough to cover bills, but little else. Our current budget is as pared-down as it can be: no cable, no landline phone, one reasonable car payment, rarely dining out, etc. We are making slow progress, but there are two important issues, as I see it:
1. Without a savings plan, any major expense - car repair, medical expense, house emergency - ends up on a credit card and immediately undoes whatever progress we’ve made.
2. We are perpetually strapped, unable to feel like we are fully participating in life (not taking vacations, rarely visiting family, feeling guilty about any money we spend on ourselves, no matter how small).

Proposed resolution:
I’m aware that this is universally frowned upon, but…
- 401k distribution to cover the entirety of the debt, or,
- 401k distribution to cover about half, and a 0% balance transfer to help us pay the rest down as quickly as possible.

I’m 44, and well aware of the 10% penalty, impact on our income tax liability when filing next year, and what it would do to our retirement bottom line if I withdraw between $30k and $60k. FYI, I’m a little less interested in a 401k loan since it just trades one debt for another, albeit at a lower interest rate which gets paid back to myself.

Why I still think this might be a good idea:
As it relates to my 401k balance at retirement age, I’ve considered three scenarios:
Scenario #1: Don’t touch 401k balance, and continue paying down debt as best we can. Contribute at a rate of 4% (to get full employer match) for the next 5-6 years, then bump contributions to 15%+ once debt-free. Meantime, pray nothing happens that will add to the debt and push the payoff date out further.
Scenario #2: Withdraw $35k from 401k, contribute 4% for the next 2-3 years to focus on paying off remaining CC debt, then bump contribution to 15%+
Scenario #3: Withdraw $60k from 401k, clear all CC debt, and immediately bump contributions to 15%+

Flawed logic time... By my math, using the calculator on Bankrate, the retirement age 401k balance of these three scenarios all end up within about $90k of one another. So am I willing to sacrifice $90k in 20+ years in order to eliminate $42k in credit card debt today? I think I might be. It would instantly change the quality of our lives, freeing up money that could be used to build up a true savings account, comfortably pay bills each month, address the deferred maintenance on our cars or house. Most importantly, it would allow us to take a deep breath and more fully live our lives now.

I keep dreaming of being debt-free, and keep wondering if this would be such a terrible way to do it. What says the community?

I would also suggest you revisit the loan option. If you haven’t already, you should create a spreadsheet which contains each card balance, minimum monthly fee & compare last months statement to this months statement so you can see how much of your payment is going towards principal & how much towards interest. You may be paying the same amount in interest every month that you could be repaying your 401k loan.

I recently did this for my boyfriend. He had about 25k in credit card debt & was in the hamster wheel of interest. We calculated his minimum monthly payment for each card. Total payments for all cards every month was about 1k. He took the 401k loan for 5 years and his monthly payback was about $500/month. He paid his debts & put back $500 in his pocket without touching his current contributions to his 401k.

Key for him was me putting all the numbers on the spreadsheet & showing him what he was spending & how much his loan payback amounts would be. Once he saw that a huge portion of his 1k was going towards interest & that his loan payback was less than the monthly credit card payments he pulled the trigger on the loan.

Hope this helps!! Good Luck!!

Re: Revisiting a classic - 401k withdrawal to pay off CC debt

wa3more — Wed, 11 Apr 2018 12:53:01 GMT

Scen 1 is best but maybe eliminate 4% contribution and use that to pay off debt.

Do not cash out/ loan against 401k. I would BK before i took out loan and i would only do bk as last resort nuke option.

Re: Revisiting a classic - 401k withdrawal to pay off CC debt

Anonymous — Wed, 11 Apr 2018 13:37:54 GMT

NO NO NO

It's your budget that is broken if you can't pay off your debt. Move somewhere cheaper, drive cheaper cars, work more, sell things, anything but touching your retirement for this.

If this is another foiled attempt at getting out of debt and something major happens down the road that drives you to a BK, you will have blown part of your 401k for nothing.

Re: Revisiting a classic - 401k withdrawal to pay off CC debt

Anonymous — Wed, 11 Apr 2018 13:43:12 GMT

You may also want to look at another side issue. In my case at least, if I take any kind of early distribution from my 401(k), I can't make contributions for 6 months.

Re: Revisiting a classic - 401k withdrawal to pay off CC debt

Dalmus — Thu, 12 Apr 2018 17:40:07 GMT

If you have to go down that road, I would prefer the loan option to the withdrawal option. The problem with the withdrawal option, besides the 10% penalty and income taxes, is that you are also losing all that potential compounding interest.

If you HAD to take the withdrawal, I would use the extra money you have monthly after paying off all your credit card debt and max out your contributions to your 401(k) as soon as you are eligible to start contributing again.

Monthly minimums on $43K in credit card debt must be rediculous... I'm coming up with nearly $1,300 and that's with a generous average rate of 16%.

Despite the legitimate concern that @SteelerNYC laid out above, I think there is something to be said about being able to having breathing room and building up a liquid emergency fund. I know you've already stripped down your monthly non-essentials, but I would also warn that many people borrow money from somwhere, pay down their credit card debt, and then can't control themselves from running the cards back up again and putting themselves in an even worse position.

Not saying that is your fate, its just a thing to watch out for!

Re: Revisiting a classic - 401k withdrawal to pay off CC debt

Anonymous — Fri, 13 Apr 2018 02:45:21 GMT

Withdrawing 60k isn't going to pay off 43k. First off 10 percent penalty makes it 54k. You don't realize how adding 60k to your income is going to increase your taxes. It is going to be a huge hit. That money is going to be taxed a much higher rate than your current income. If you declare bankruptcy they can't touch your 401k.

Re: Revisiting a classic - 401k withdrawal to pay off CC debt

Anonymous — Sat, 14 Apr 2018 20:37:34 GMT

@Anonymous wrote:
Even though you have decided against, I would look again at the 401(K) loan option, to see what the interest rate is. A smaller interest rate could make things much easier (although depending on the plan you might have a shorter payback time).

The other thing to consider is a short term impact on taxes. Apart from the 10% penalty, you also have to pay tax on the entire withdrawn amount which is treated as income, which might push you into a higher tax bracket. Whether that matters to you compared to the benefit of being out of debt is for you to decide.

My advice would be to go to a fee only financial planner and get a 1 hour appointment, and let him/her give you their thoughts. It's a fairly big decision, IMO too big to go by consensus on an internet forum.

Thanks for the feedback. I do plan to talk to a financial planner - that's great advice. This decision will not be made lightly, and I definitely intend to be as informed as possible. As for the tax liability, I'm aware and have run various scenarios through online tax estimators to get an idea of what we would owe next year. (If I do move forward, it looks like I could withdraw $60k having 30% withheld. That would net us the $42k we need, while having enough withheld to cover our estimated 2018 income tax and the 10% penalty.) And since a few people here have mentioned it, I'm reconsidering loan options, as well. It might be the lesser evil, allowing loan interest (5.75%) to be paid back to myself, even if it does come with its own handful of downsides.

Re: Revisiting a classic - 401k withdrawal to pay off CC debt

Anonymous — Sat, 14 Apr 2018 21:08:47 GMT

@Anonymous wrote:
Withdrawing 60k isn't going to pay off 43k. First off 10 percent penalty makes it 54k. You don't realize how adding 60k to your income is going to increase your taxes. It is going to be a huge hit. That money is going to be taxed a much higher rate than your current income. If you declare bankruptcy they can't touch your 401k.

Thanks for your feedback. Since the tax code just changed, there are lots of online calculators that are giving me an idea of what our tax bill will look like next year - no reason for it to be a big surprise. It also won't put us in a higher tax bracket, so this money shouldn't be taxed at a higher rate than our current income. A $60k withdrawal withholding 30% would net us $42k, with enough held back for tax and penalty (combining with our current income/withholdings).

Declaring BK has been mentioned a couple times as a preferable option to a 401k loan/withdrawal, and I have to admit, I feel like I'm missing something. I get that 401k's are protected in BK, but it seems like it would come with a bunch of other credit-ruining downsides, following us around for the next decade. Not sure why that would be preferred to paying our debts, even if that means having a little less income in retirement, or potentially having to retire a year later than we planned. To me, maybe that's the price we pay for allowing ourselves to get to this point in the first place.

I appreciate everyone's input here. It's a difficult decision, and I just want to consider all sides.

Re: Revisiting a classic - 401k withdrawal to pay off CC debt

MyDataMyChoice — Sat, 14 Apr 2018 22:11:20 GMT

NO NO NO NO NO NO NO NO NO

Okay now thats out of the way...

Withdraw from 401K or Loan from 401K is NEVER a good option

You are STEALING from yourself.... that money is OUT OF PLAY from the market as you have it on loan... its not just costing you 5.75%APR....

401K is not touchable by creditors.... even during bankrucpy... *up to 1.2M

NEVER touch your retirement accounts... not to mention the 'boom' to the next tax bracket and the penatly alone...

DONT DO IT

Re: Revisiting a classic - 401k withdrawal to pay off CC debt

MyDataMyChoice — Sat, 14 Apr 2018 22:12:53 GMT

Can you get a LENDING CLUB or PROSPER Consolidation Loan? Maybe both of you can get one?

Re: Revisiting a classic - 401k withdrawal to pay off CC debt

Anonymous — Sat, 14 Apr 2018 22:31:43 GMT

I didn't say to declare bankruptcy but if 43k in debt is causing you such hardship it might be something to think about. My thought is if you run into an issue down the road you have money in your 401k is safe.

You are 44 so you only have 20 years left.
Also since 43k in debt is causing you such financial hardship I am guessing it will be quite a while for you to get back that 60k into your 401k. And you are throwing 6k into the garbage. Do you have state income tax?

If I was going to take money from 401k it would be a loan. No penalty and the interest is low and you are paying yourself back. Thinking short term is what got you into this problem . Withdrawing 60k from your 401k is short term thinking. You have to change how you think about financial problems.

Re: Revisiting a classic - 401k withdrawal to pay off CC debt

Appleman — Sun, 15 Apr 2018 15:01:34 GMT

Also, if the money is with your current employer you may not be able to access the money until you leave the company.

I have to agree that using retirement to pay current debt looks like a tempting way out but it will truly cost you much more than you could anticipate.

Re: Revisiting a classic - 401k withdrawal to pay off CC debt

Anonymous — Sun, 15 Apr 2018 20:18:23 GMT

While others are saying no, don't ever - I say it may make sense for you and your situation. For some, $43k might be 50% of their 401K which means the loss will be a large hit. For someone else, it could be just 10% of their current 401k making a smaller impact on overall retirement savings.

In either case, you will have less to retire on and will need a firm plan to replace this money. How aggressive this needs to be will depend on where you are in your retirements savings.

A straight withdrawal will likely take far more paperwork and may require you to share more of your personal life with your employer than you wish if they only offer hardship withdrawals. Sometimes withdrawals are only allowed to stop foreclosures (and only enough to cover the amount to stop) or medical expenses etc.

A loan can often be done between you and the 401K company and doesn't cost you all the tax money. Its a loan that doesnt show on the CRA's, often has a lower interest rate than a personal loan, and comes right out of your paycheck. Your retirement still takes a hit but a smaller one as you pay it back each week with interest. Be sure to add these weekly payments to your calculations as to what it takes to recover from the loan funding.

While BK is an option, it will effect your credit report and interest rates for the next 10 years - CC's, auto loans, any mortgages etc. These potential costs also need to be calculated against the lost retirement funds.

My 2 cents in covering some other opinions.

Re: Revisiting a classic - 401k withdrawal to pay off CC debt

expatCanuck — Mon, 16 Apr 2018 03:41:54 GMT

I was in the OP's shoes not quite a year ago, and prematurely liquidated IRA funds to get my finances back in order. Not the best of things, not the worst.

Pros

Allowed me to get out from under crushing CC debt.
Allowed me to rehab my FICO scores and refi our mortgage to a more advantageous rate for a shorter term.

Expected Cons

Took a significant tax hit
Lost about 3 years' worth of retirement contributions (and their earnings).

Unexpected Con

Costly Estimated Tax payments for the subsequent fiscal year

What I Learned:

1) It's all for nothing if you don't adopt a pay-in-full approach to credit cards going forward.

2) Budget, budget, budget -- at least a year in advance.

3) Consult an accountant to fully understand the tax implications of all approaches open to you.

4) As already noted above, factor into your budget both the tax to be paid in the current year AND an Estimated Tax payments for the subsequent tax year.

All said & done, I'd do it again, but be more conservative with the budget. Our budget this year has gone to Hades because of the Estimated Tax payments.

Re: Revisiting a classic - 401k withdrawal to pay off CC debt

beutiful5678 — Mon, 16 Apr 2018 03:34:15 GMT

@Anonymous wrote:
And since a few people here have mentioned it, I'm reconsidering loan options, as well. It might be the lesser evil, allowing loan interest (5.75%) to be paid back to myself, even if it does come with its own handful of downsides.

Don't underestimate the psychological benefit of this. Personally, I would find it much more rewarding to pay myself interest than a bank. (Not to mention the payments will be lower because the interest rate is lower.)

Re: Revisiting a classic - 401k withdrawal to pay off CC debt

iced — Mon, 16 Apr 2018 15:19:52 GMT

@Anonymous wrote:
Hello! Hoping someone can help me punch holes in my extremely flawed logic. First, sorry for the long post... I’m very aware of the conventional wisdom on this topic (and the good reasons for it), but I’m wondering if there are circumstances where cashing in a portion of a 401k to eliminate credit card debt is an acceptable solution? For a variety of reasons – some justifiable, some maybe not – my wife and I have accumulated $43k in CC debt. Having lived with this for a number of years now, and felt the enormous weight and pressure it can put on personal finances, we are absolutely committed to never getting here again. Ever. When it’s gone, it stays gone.

For the past few years, we have been trying to aggressively pay down the debt, paying as much as we can monthly, leaving ourselves enough to cover bills, but little else. Our current budget is as pared-down as it can be: no cable, no landline phone, one reasonable car payment, rarely dining out, etc. We are making slow progress, but there are two important issues, as I see it:
1. Without a savings plan, any major expense - car repair, medical expense, house emergency - ends up on a credit card and immediately undoes whatever progress we’ve made.
2. We are perpetually strapped, unable to feel like we are fully participating in life (not taking vacations, rarely visiting family, feeling guilty about any money we spend on ourselves, no matter how small).

Proposed resolution:
I’m aware that this is universally frowned upon, but…
- 401k distribution to cover the entirety of the debt, or,
- 401k distribution to cover about half, and a 0% balance transfer to help us pay the rest down as quickly as possible.

I’m 44, and well aware of the 10% penalty, impact on our income tax liability when filing next year, and what it would do to our retirement bottom line if I withdraw between $30k and $60k. FYI, I’m a little less interested in a 401k loan since it just trades one debt for another, albeit at a lower interest rate which gets paid back to myself.

Why I still think this might be a good idea:
As it relates to my 401k balance at retirement age, I’ve considered three scenarios:
Scenario #1: Don’t touch 401k balance, and continue paying down debt as best we can. Contribute at a rate of 4% (to get full employer match) for the next 5-6 years, then bump contributions to 15%+ once debt-free. Meantime, pray nothing happens that will add to the debt and push the payoff date out further.
Scenario #2: Withdraw $35k from 401k, contribute 4% for the next 2-3 years to focus on paying off remaining CC debt, then bump contribution to 15%+
Scenario #3: Withdraw $60k from 401k, clear all CC debt, and immediately bump contributions to 15%+

Flawed logic time... By my math, using the calculator on Bankrate, the retirement age 401k balance of these three scenarios all end up within about $90k of one another. So am I willing to sacrifice $90k in 20+ years in order to eliminate $42k in credit card debt today? I think I might be. It would instantly change the quality of our lives, freeing up money that could be used to build up a true savings account, comfortably pay bills each month, address the deferred maintenance on our cars or house. Most importantly, it would allow us to take a deep breath and more fully live our lives now.

I keep dreaming of being debt-free, and keep wondering if this would be such a terrible way to do it. What says the community?

I withdrew about $25k from a 401k to pay off CC debt about 10 years ago. Today, I'm completely debt-free and saving like a fiend.

It was one of the dumbest and worst things I could have done and I still stress about it regularly. Because of that one withdrawal, I will very likely not be able to retire until I'm in my 70s. Instead of all my money going to CC debt, now all my money goes to retirement savings because I screwed myself 10 years ago. Maybe you won't regret it the way I did, but if you do, you'll just be trading one stress for another.

If you're looking for the flawed logic, it's that you cannot predict the equities market in 5, 10, or 30 years, and money withdrawn is not only lost to compounding/dividend, when it re-enters your retirement plan later it'll be at current prices. $10k invested in Apple in 1995 will return more by 2020 than $100k invested in 2005. I withdrew in 2008, right as the bottom was starting to fall out. That $25k withdrawal was more like $35k a year before. Even worse, that $25k would have been $150k in 2015. It could well have been $600k or more by 2040 when I would have liked to retire. Thus, I may well have paid over half a million dollars to wipe out $25k in debt.

There's always other ways out. Inquire with the CCs about hardship plans. Downsize or take on a roommate at your home. Sell valuables you may not need.

If you can score a lower-interest loan or BT, it's a way to go but you better make very sure you're both on the right mindset for getting out of debt. Alcoholics don't kick the habit with more alcohol, and this can just as easily send you deeper into debt if you fall off track.

Re: Revisiting a classic - 401k withdrawal to pay off CC debt

Dalmus — Wed, 18 Apr 2018 18:59:40 GMT

withdrew about $25k from a 401k to pay off CC debt about 10 years ago. Today, I'm completely debt-free and saving like a fiend.

It was one of the dumbest and worst things I could have done and I still stress about it regularly. Because of that one withdrawal, I will very likely not be able to retire until I'm in my 70s. Instead of all my money going to CC debt, now all my money goes to retirement savings because I screwed myself 10 years ago. Maybe you won't regret it the way I did, but if you do, you'll just be trading one stress for another.

If you're looking for the flawed logic, it's that you cannot predict the equities market in 5, 10, or 30 years, and money withdrawn is not only lost to compounding/dividend, when it re-enters your retirement plan later it'll be at current prices. $10k invested in Apple in 1995 will return more by 2020 than $100k invested in 2005. I withdrew in 2008, right as the bottom was starting to fall out. That $25k withdrawal was more like $35k a year before. Even worse, that $25k would have been $150k in 2015. It could well have been $600k or more by 2040 when I would have liked to retire. Thus, I may well have paid over half a million dollars to wipe out $25k in debt.

There's always other ways out. Inquire with the CCs about hardship plans. Downsize or take on a roommate at your home. Sell valuables you may not need.

If you can score a lower-interest loan or BT, it's a way to go but you better make very sure you're both on the right mindset for getting out of debt. Alcoholics don't kick the habit with more alcohol, and this can just as easily send you deeper into debt if you fall off track.

Withdrawing the money is definitely the absolute last resort, for sure. But had you taken a loan for $25k against your 401(k), your story world be much different. You would have had to budget to pay back the $25k, but you wouldn't have lost the potential compound interest.

Of course, not all employers allow this... but if they do, it's a much better option.

Re: Revisiting a classic - 401k withdrawal to pay off CC debt

Anonymous — Thu, 20 Sep 2018 13:57:20 GMT

Hi there, your post is nearly 6 months old now but I am wondering what action you took and how it has worked out for you?

I find myself in a similar situation and interested in hearing your experience if you are willing to share. Thank you