A Reddit user is considering taking money out of his 401(k) to pay off his credit cards. His cards are at 24% interest, which is a very high rate. If he withdrew funds from his 401(k), he could be debt-free and keep more of his money in his own pocket.
So, is it a good idea to raid the retirement account to pay off what he owes?
Does it make sense to pay off credit card debt with 401(k) funds?
The Reddit user absolutely should not take $16,000 out of his 401(k) to pay off his credit card debt. There are a few reasons for that.
First, withdrawing money early from a 401(k) will result in a 10% penalty, and the Reddit poster will have to pay taxes on the withdrawn funds at his ordinary income tax rate. This would mean he’d need to take more than $16,000 out of his account in order to be able to pay off the card. The specific amount he’d need to withdraw depends on his tax bracket, but it would likely be well over $20K. He’d also lose a lot of money due to the penalty.
Second, if he withdraws the money, he’d lose all the gains it would have made over the rest of his career until retirement. So, let’s say he’s 30 years away from retirement and earns 10% average annual returns. If he took $20K out of his retirement account to pay off his debt, his account would end up with $348,988.05 less money in it because he’d miss out on 30 years of compound interest that $20K would have earned him.
The cost is obviously far too high, and the Reddit user should look into other alternatives.
What about a 401(k) loan?
Some Redditors suggested that instead of withdrawing the money, the poster should take a 401(k) loan instead. He’d be able to avoid the 10% penalty if he did this, and he would pay the money back, so he wouldn’t miss out on decades of compound interest.
However, this also isn’t a great idea. There’s a chance that he wouldn’t put the money back, so he’d still be gambling on his retirement security. He might also have to sell investments at a bad time to pay off the debt and could miss out on gains the money would have made during the time he’s paying back the loan.
What’s the best way to tackle credit card debt?
Rather than raiding his retirement accounts, the Reddit user should instead create a different plan to repay his credit card debt as soon as possible.
There are many different approaches he could take. One of his best options would be to explore a balance transfer card or a personal loan, both of which could allow him to reduce the rate on the debt he’s paying off.
If he qualified for a balance transfer card at a 0% promotional rate, he’d likely pay a 3% or 4% fee up front and be able to repay his debt for 12-15 months at a 0% rate, so the entire payment would go to principal. This would be far cheaper than his current card. If he used a personal loan, on the other hand, he could probably lower the rate to around 8% to 12%, depending on his credit, and he’d have fixed monthly payments to make for a set number of years before becoming debt-free.
He should also get aggressive about making extra payments, either to his current cards if he can’t refinance or to his new loan. He should cut spending to the bone until he has his debt paid off and even consider working a side gig for a while.
Doing this should help him deal with the debt quickly while leaving his retirement account balance intact. This is the best path forward to a secure future, along with making a plan to live within his means and never end up in credit card debt again.
A financial advisor can help with this process and help set him on the path to financial success, so he should strongly consider consulting with a professional for help deciding on the best path forward.
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