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

New Member

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

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?

Message 1 of 21
20 REPLIES
Mega Contributor

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

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.

Message 2 of 21
Regular Contributor

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


@r90pbmw 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!!



Message 3 of 21
Established Contributor

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

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.

Message 4 of 21
Valued Contributor

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

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.

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Message 5 of 21
Frequent Contributor

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

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.  

Message 6 of 21
Established Contributor

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

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!

 

 

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Message 7 of 21
Valued Contributor

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

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.

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Message 8 of 21
New Member

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


@longtimelurker 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.

Message 9 of 21
New Member

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


@frogman1 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.

Message 10 of 21