Is It Wise To Use Retirement To Pay Off Debt
Youll lose potential returns on retirement savings if you use your retirement funds to pay off debt, but youll also eliminate interest payments on your debt. Its a wise move during down markets, but not during a bull market, when stock values are rising. In that scenario, it doesnt make sense to use retirement to pay off debt.
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How Much Can I Borrow From My 401
The maximum anyone can borrow is $50,000. Even if you have a $1 million in your account, $50,000 is the most you can borrow under federal guidelines. If you have less than $100,000 in your account, you only can borrow as much as half your balance so if you have $84,000 in your account, you can borrow no more than $42,000. Some plans offer an option that allows you to borrow as much as $10,000 even if your account has less than $20,000 vested. Again, you need to read your plans rules or talk to your employer or plan administrator to learn more.
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The Wrong Way To Borrow When Youre In Debt
If youve fallen into a ton of debt to a variety of different creditors and your total balance continues to go up every month, then one of the most dangerous things you can do is continue on that same course. After all, its this kind of spending, and these kinds of financial habits, that have caused you to go this deeply into debt in the first place. More of the same isnt going to help.
If youre borrowing to finance a lifestyle that you cant afford, then you need to stop. It seems simple, doesnt it? So, how can you tell if youre living outside of your means?
First, check your attitude. What kind of mentality drives your financial decisions? Why do you spend the money that you spend, and why have you allowed yourself to go into debt? Is it because you were thinking soundly about your long-term financial future? Or, is it because you couldnt control your impulses and bought things you didnt really need because you couldnt bear the thought of not having them?
Often, our attitudes are a mix of the two. We want to be responsible and make sound financial decisions, but we have moments of weakness where we overspend or rely too much on credit. It only takes a handful of those moments for debt to get out of hand.
If you came out on the wrong side of the three considerations above, its time to get serious. And, if youre using credit or debt financing to get by, its time to stop and realize that it can, and will, get worse.
Should You Consider Taking Money Out Of An Ira To Pay Debt
Assuming you’re under age 59 1/2, you should borrow money from your IRA only if you’re confident that you can pay it all back within the 60-day deadline. If you can’t, then you almost certainly will forfeit 10 percent of the money as an early withdrawal penalty, and you will lose the tax protection the money enjoys while it is sitting in an IRA account. Just about any other debt-reduction solution would be better in this situation, so if you can take out a personal loan or sell things to pay down your debt, consider those options first.
If you really have exhausted all the options and you need to access your IRA, despite the penalties and taxes, then be as tax-conscious as you possibly can. Pick the debt with the highest interest charges to pay off first, and withdraw the exact amount you need to pay it off not a dollar more. When figuring out how much to withdraw, calculate the amount of penalties and taxes, and add it to the amount of debt you wish to pay off. If the withdrawal is going to push you into a higher tax bracket, think about withdrawing the money over two tax years to minimize your tax bill.
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Downsize Especially If Home Prices Are Rising
If you own your homeor most of your homeconsider scaling back on your house size and amenities, particularly if you are lucky enough to live in an area where housing prices have risen significantly.
Take that hard-earned equity and move into a smaller home thats cheaper to maintain, and hopefully has more predictable repair costs and property taxes into the future. You may also choose to take your money and use it to buy a house in an area with a lower cost of living, if family circumstances allow.
The problem is that a retiree may find it difficult to qualify for a mortgage. So, if there is equity in the house, that may well be the upper limit of a downsize, Chen says.
How Much Can I Borrow From My 401k
Current IRS rules allow you to borrow up to 50% of your vested account balance or $50,000, whatever amount is less. However, if your account balance is $10,000 or less, you can borrow up to the total balance or $10,000, whichever is less.
Whatever amount you borrow generally must be repaid in five years.
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Should You Use A 401 Loan To Pay Off Your Credit Cards
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Many 401 plans allow users to borrow against their retirement savings. Its a relatively low-interest loan option that some people use to consolidate credit card debt meaning, taking a more favorable loan to pay off several high-interest credit card balances. But NerdWallet cautions against taking a 401 loan except as a last resort.
Change Your Spending Habits
With a budget in place, youll see how much more you need or which expenses you can cut. You probably dont need a latte from Starbucks every morning, or you can pack your lunch instead of eating out every day. Rethink your spending habits, and youll discover ways you can save extra bucks to pay off your debt.
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Other Options For Paying Off Debt
Most financial advisors highly recommend leaving your 401k alone instead of using it to pay off debt. Instead, if you would like to pay it off more quickly or get out from under a few bills, consider these options:
- Finding a side gig like Uber, Doordash, or babysitting to make extra money in the evenings and weekends. Even 50 to 100 dollars a week can knock out a medical bill or credit card payment in a few months.
- Sell some belongings that you arent using. Consider consigning clothes, selling old electronics that you dont use any more, or, in more extreme cases, a vehicle with a high payment and high insurance costs.
- Look into debt consolidation that can lower your interest rates and monthly payments.
In cases of high debt that you are struggling to pay off, filing for bankruptcy may be the right option. Your 401k is protected during bankruptcy and cant be used to pay off creditors so your money is still growing for your retirement.
K Plan Early Withdrawal Penalty Exceptions
According to the IRS, several exceptions allow you to take money out of your 401k before the age of 59 1/2. The following are qualifying exemptions:
- If you die early, the government will let your beneficiaries access your retirement account without penalty
**Be sure to check with a tax professional before taking money out of your 401k plan to ensure tax laws have not changed.
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You can convert an IRA or a 401 plan from a previous job into a Solo 401. From there, the IRS will allow you to be your own bank. What this means is the IRS will allow you to access money inside your Solo 401 penalty- and tax-free under the following conditions:
You can withdraw up to 50% of an account’s value or $50,000 .
You must pay your Solo 401 plan back the amount withdrawn within five years to avoid paying any penalties and taxes on the money taken out.
The IRS requires an interest rate on this loan. It is the prime rate plus 2%, so the current interest rate would be 5.25%. The 5.25% would be interest going back to the Solo 401 instead of going to the banks.
Suppose an entrepreneur owes $25,000 on a credit card charging 17% in interest. They look at their retirement account statement and realize they are making 6% per year on their account valued at $50,000. The idea of using the retirement account to pay off the high-interest-rate debt is appealing, so they take the existing retirement account and convert it into a Solo 401 plan. With the Solo 401 having $50,000 in it, they take out $25,000 from the account and use that $25,000 to pay off the credit card debt in one shot. Instead of making a monthly payment to a bank and losing 17% per year, they are now making a monthly payment back to their Solo 401, and the 5.25% interest is money they keep.
What makes this loan feature unique is there are no restrictions on using the money.
How To Pay Off Debt In Retirement
Should you be concerned about your debts in your retirement? The short answer is yes.
If possible, it’s best to avoid carrying debt in retirement. Studies have linked credit card debt with increased stress and even physical pain. Meanwhile, older adults without such burdens find it far easier to manage their finances and make ends meet.
According to the Federal Reserve Bank of New York, from 1999 to 2019, debt among Americans over the age of 70 climbed a whopping 543%. A 2021 report by Experian found that the average credit card debt held by baby boomers was $6,230, while the average credit card debt held by the Silent Generation was $3,821.
Households of people ages 70-plus are more likely than before to have credit card debt, mortgages and even student loans.
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Mistake: Signing Up For A Debt
It is rare to get a quick-fix solution to debt problems. If that is one of the promises you hear, start looking elsewhere. Remedy: The first thing to understand is that debt-relief programs typically take 3-5 years, so be patient. Second, check up on the whatever company you choose for debt relief. The Better Business Bureau or local state attorneys office are good places to start. Credit unions, universities andmilitary bases should be reliable sources for recommendations. Be sure whatever organization you choose is licensed and doesnt have a record of consumer complaints.
Should I Borrow From Retirement Accounts To Pay Off Debt
Getting your debt payoff plan kicked off can take a while as you slowly chip away at your balances with what little money you have left over each month. If you have been doing some things right financially like setting up automatic payments into your retirement account you find yourself with some financial assets that you can use to pay off your balances.
You can withdraw funds from your retirement accounts to pay off debt, but this is normally a horrible idea. If you withdraw funds from a pre-tax retirement account like a 401k or Traditional IRA you will not only pay an early withdrawal fee of 10%, but you also have to pay income tax. Assuming youre in the 25% tax bracket that means 35% of your withdrawal will disappear as taxes and fees. A withdrawal of $10,000 would only net you $6,500. Thats a horrible return of your funds and we havent even discussed the missed growth on those funds for your retirement.
Another option to consider if you have some money stashed away in retirement accounts is to get a loan of those funds that you will pay back. But is raiding your retirement accounts via a loan to pay off your debt a smart idea?
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Alternatives To A 401 Loan
Although 401 borrowing has some advantages, including not having to jump through hoops for a commercial loan or undergoing a check of your credit score, there are downsides that discourage many would-be borrowers from using their retirement money in the present. Here are a few:
- Tax penalty for not repaying the loan on schedule.
- Loss of growth. 401 money could be invested in a mutual fund and grow tax free for many years until you retire. Money borrowed doesnt grow, and the loss of compounding growth can make a big difference in your older years.
- You could get in the habit of using your 401 as a piggy bank, defeating its value as a savings tool.
- While you are paying back what you borrowed, you might not have the money to add to your account, further reducing its future value.
- 401 accounts are protected in bankruptcy. If you borrow money to help pay off a big debt and then discover that you still cant avoid bankruptcy, you will lose whatever you withdrew. Not touching the 401 safeguards the money for your retirement.
After considering the drawbacks, many would-be 401 borrowers decide to look elsewhere for the money they need. Here are a few options:
Retirement Savings Can Benefit
As you make loan repayments to your 401 account, they usually are allocated back into your portfolio’s investments. You will repay the account a bit more than you borrowed from it, and the difference is called “interest.” The loan produces no impact on your retirement if any lost investment earnings match the “interest” paid ini.e., earnings opportunities are offset dollar-for-dollar by interest payments.
If the interest paid exceeds any lost investment earnings, taking a 401 loan can actually increase your retirement savings progress. Keep in mind, however, that this will proportionally reduce your personal savings.
Borrowing To Pay Off Debt: The Right And Wrong Way To Do It
April 26, 2017 by National Debt Relief
People borrow money for many different reasons. Some are understandable some are obvious mistakes.
When you borrow to finance your education, rent a car, pay off an emergency medical bill, or make a necessary home repair, thats understandable. When you borrow large amounts of money to pay for luxuries, such as expensive clothing, trips, meals, and electronics, then youre likely making a financial mistake that youll grow to regret.
However, when youre borrowing money and going into deeper debt just to keep up with your original debt payments, thats an entirely different level of ill-advised.
Youre essentially paying another creditor just for the privilege of barely keeping up with your monthly minimum payments. By financing your debt, youre not just borrowing enough to make your payment, you are going to face tacked on interest charges, on top of your other interest charges!
The result is that youll end up in more debt than you were in the first place because you decided to tread water with your finances.
Going into more debt just to pay off your current debts is not the solution unless you have a strategy and know exactly what youre doing.
Risks Of Taking Out A 401 Loan
Before deciding to borrow money from your 401, keep in mind that doing so has its drawbacks.
You may not get one. Having the option to get a 401 loan depends on your employer and the plan they have set up. A 2020 study from retirement data firm BrightScope and the Investment Company Institute says that 78 percent of plans gave participants the option to borrow based on 2017 data. So you may need to seek funds elsewhere.
You have limits. You might not be able to access as much cash as you need. The maximum loan amount is $50,000 or 50 percent of your vested account balance, whichever is less.
Old 401s dont count. If youre planning on tapping into a 401 from a company you no longer work for, youre out of luck. Unless youve rolled that money into your current 401 plan, you wont be able to use it.
You could pay taxes and penalties on it. If you dont repay your loan on time, the loan could turn into a distribution, which means you may end up paying taxes and bonus penalties on it.
Youll have to pay it back more quickly if you leave your job. If you change jobs, quit or get fired by your current employer, youll have to repay your outstanding 401 balance sooner than five years. Under the new tax law, 401 borrowers have until the due date of their federal income tax return to repay in such circumstances.
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