If you have a lot of money set aside in your 401k, should you be using retirement to pay off debt? As you are looking at your high-interest credit cards and loans, it might be tempting to liquidate assets for debt repayment purposes. But make sure you talk to a financial expert before making any sudden financial moves.
Drawbacks of Withdrawing Retirement Funds
People who are using retirement to pay off debt often face the decision to withdraw their retirement funds before reaching retirement age. Even though the credit card interest rates are higher than the tax rate, you will have a long list of costs that will be incurred for early withdrawal.
Plus, you need to consider the long-term consequences of depleting your retirement account. Retirement financial strategies are most effective over the long term. Using retirement to pay off debt might interrupt this strategy, making it hard to recover by the time you reach retirement age.
Future Retirement Strategy
Do the math to see how you will change your financial trajectory by pulling money from your retirement account. Yes, it can bring financial peace to pay off your debts. But you will be left with a high tax bill on the withdrawn funds. Withdrawing from a 401k means that you not only pay ordinary income tax, but an additional 10% penalty is added to the bill. Additionally, reduced cash will be available when you finally reach retirement age.
If the numbers add up and you still feel like using retirement to pay off debt is a good idea, then you will need to determine your withdrawal eligibility. For example, you might only be eligible to withdraw elective-deferral contributions (the amount deposited beyond what your employer contributed).
Short Term Debt Repayment for Long Term Retirement Benefits
You are young and healthy right now, which means that is more effective to leverage your income-earning years so you are prepared for the future. What other debt payoff possibilities are available as an alternative to draining your retirement account?
Instead of using retirement to pay off debt, look for ways to restructure your budget and free up cash flow. Another option is to take on a part-time job with the goal of paying down your debt balances as soon as possible. A little extra work right now will be worth it when you can enjoy retirement debt-free.
Every situation is unique, which is why your best solution is to talk to a financial expert. Then, you can evaluate your options to decide if using retirement to pay off debt is a good fit for your short-term and long-term financial goals.