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Impact on benefits
Some benefits are based on the income you have coming in, and the amount of savings you have.
So if you take money from your pension to pay off debts, it might reduce the amount of money you can get from benefits both now and in the future.
Even if you use the money you take from your pension to pay off debts, the payment of some benefits is still affected.
Find out more about benefits in our guide Universal Credit explained
Impact on tax
Taking money from your pension can have an impact on how much tax you pay, and the tax relief that you get.
Usually, 25% of your pension is paid to you tax-free. The remainder will be subject to tax. This 25% tax-free figure is often known as a pension lump sum and can be used to pay debt if you decide that is right for you.
But cashing in your pension to pay off debt might leave you with a large tax bill that you werent expecting, and the amount of tax you pay reduces what youll get from your pension pot.
If you take money out of a defined contribution pension pot above the 25% tax-free part, you could also be affected by the Money Purchase Annual Allowance .
How Youre Using Leverage Already
Most of us already use leverage of some sort, whether out of convenience, financial torpidity, or necessity. Lets run down a non-comprehensive list of common uses of leverage of which you may not be aware.
You own stocks, and many stocks are leveraged. Many publicly traded and private companies issue bonds, which is debt that theyve guaranteed against future income so they can grow or maintain operations. The debt that these companies issue is bought by other entities for the purpose of securing that coupon or interest payment. Enron is a classic example of a company built on mountains of debt which it used to purchase companies, build gargantuan energy infrastructure, and pay huge bonuses to executives in anticipation of future earnings. The Smartest Guys in the Room by Bethany McLean is a fascinating look into the now eponymous tale of financial malfeasance if youre looking for some continuing financial education until WCICON22.
You have a mortgage. While interest rates are tantalizingly low at the time of this writing, mortgage debt is still leverage. Youre using borrowed money to finance other things in your life: groceries, vacations, furniture, daycare, utilities, that new Tesla Model Plaid, etc. If you have mortgage debt, that’s perfectly fine. Just know everything you buy until then is on borrowed money. As an aside, did Elon Musk have to pay royalties to Spaceballs for appropriating the Plaid moniker?
Should You Use Retirement Funds To Pay Off Credit Card Debt
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Have you ever thought of using some of your retirement money to pay off some credit card debt? We recently received a question from someone who wanted to use money from an old 401 to do just that. Would this be a good idea for her? As you’ll see, it’s not as simple as it may seem.
Let’s take a look at some of the pros and cons. Since she’s under age 59 1/2, she would have to pay a 10% penalty on the withdrawal in addition to regular income taxes. However, she would have to pay taxes on the money eventually anyway and the one-time 10% penalty is still a lot less than the 18% interest she was paying on the debt each year.
In this case, her credit card debt was about $18k. If she just paid the$285 minimum monthly payment, it would take about 16 1/2 years to pay it all off and she would have paid over $38k in interest to the credit card companies! That sounds like a good reason to pay it off with the 401 money.
But since she’s in the 25% tax bracket and has to pay that 10% penalty, she’d have to withdraw $27,692 from her 401 to pay off that $18k debt. If instead she left that money in the 401 for that 16 1/2 years and earned 8% on it, it would be worth about $98,593. Even after paying 25% of that in taxes, she still would have earned more in her 401 than she would have paid in interest on the debt.
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Need Someone To Talk To About Your Finances
If youre struggling with money, you can talk to a specialist today, online or by phone, who will be able to help you start sorting out your financial problems.
Find free, confidential advice now using our free Debt advice locator tool
Before you take any money out, you need to know what the effects might be now and in the future.
Three important things to think about are:
- the impact on your future income from your pension
- the impact on your State benefits
- the impact on your tax position, both now and later.
Can Student Loans Affect My Social Security Benefits
If you have federal student loans with a payment schedule and no late payments, you don’t have to worry about losing your Social Security benefits. The federal government can only claim your Social Security benefits or withhold wages if you are in default. So keep paying your student debt every month.
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Early Traditional Ira Withdrawals
If you plan on making an early Traditional IRA withdrawal, you will need to pay taxes on the entire distribution amount because these accounts are funded with pre-tax dollars.
When you dont qualify for one of the penalty-free early distributions, you also need to pay the 10% early withdrawal penalty too. For the same $10,000 withdrawal, you can anticipate only being able to spend $7,000 once your brokerage withholds 30% for taxes and penalties.
How To Use Leverage And The Differences Between Good And Bad Debt
Give me a lever long enough and a fulcrum on which to place it, and I shall move the world. Archimedes
Leverage has practically become common investing parlance today. Youve got debt detractors like Dave Ramsey who believe leverage is investing apostasy, the fast track to the poor house. On the other side of the conversation, youve got Thomas Anderson who literally wrote the book The Value of Debt and who advocates up to 30% of your net worth leveraged with your human capital as functional collateral. Further stoking the conversation about leverage is the historic amount of capital being pumped into our nations economy by politicians. With bond yields low, cash generating a negative real return, and stock prices at 20-year-high P/Es, the question of how to safely boost returns deserves a thoughtful exposition on the use of leverage.
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Factors To Consider Before Putting Your Money To Work
Joyce Chan / The Balance
If youve got debt, youre not alone. Nationally, household non-housing debt is at the highest level since 2008. Housing debt is a bit higher than it was in 2009, toward the end of the Great Recession. Should you strive to reduce your share of that credit card, student loan, and housing debt, or place your money in a retirement savings account or other investments? The answer is: You should do both.
But lets look at the factors that go into prioritizing investing versus debt payoff, with the help of two experts.
Howard Dvorkin Cpa Answers
Before I answer your question, Tommy, I want to remind you and everyone else what it means to co-sign a loan. In five words, it means: Their loan is your loan.
In a lot more words, that means if your children stop making payments, you must. Youre legally responsible for whatever amount is left on the loan. The lender can sue you for the balance. Five years ago, a poll showed that the most common co-signers were older than 50, helping a child or stepchild. That sounds like you fall into that category, Tommy. Heres what else that poll showed: 38 percent of co-signers had to pay some or all of the loan or credit card bill because the primary borrower did not.
Im focusing on this first because it goes directly to your solution: Borrow from your retirement, pay off those student loans, then the kids can pay me back. It sounds like youre paying some or all of those loans now. You need to ask yourself a tough question: If you sacrifice your retirement earnings because withdrawing funds mean they arent there to keep growing will your children be diligent about paying you back?
If youre certain the answer is a resounding yes, then lets consider your question by looking at the math.
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Saving Money May Seem Like The Sensible Thing To Do But If You Have Debt It May Not Be Your Best Option
Today, debt is everywhere. At the last count, households in the UK had £1.28 trillion of debt 1. Debt comes in the obvious forms of credit cards and overdrafts. But its also in the form of things we consider pretty commonplace things like mortgages and student loans. Debts we need to further our education or to build a life.
To view all borrowing as bad is unfair, says Avivas Head of Savings and Retirement, Alistair McQueen. Borrowing, and its repayment, helps us spread our expenditure over time.
Its a mindset that can be hard to understand. Since childhood, were brought up to think that saving money is important. Having three months worth of money stowed away to help if you suddenly lose your income, or need to cover a big household repair, is undeniably a good idea. But if youve got high-interest, short-term debts? Prioritising your savings isnt always the best thing to do.
How To Decide Which Student Loans To Pay Off First
- First pay off your student debt at the highest interest rate. View the different loans and compare the respective interest rates.
- Pay off the smallest student loan first.
- View the conditions of your student loan.
- Refinancing a student loan.
Forgivable loan]What if my debt is forgiven? What happens if my debt is forgiven? The tax consequences of debt forgiveness or debt forgiveness depend on your individual facts and circumstances. If you borrow money from a commercial lender and the lender later repays or cancels the debt, you may need to include the exempt amount in your tax income.Should all student loans be forgiven?First, all outstanding studâ¦
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Are 401 Withdrawals Subject To Taxes And Penalties
Even if you can qualify for a hardship distribution, its a good idea to plan to pay taxes on the distribution . And, unless you meet specific criteria to qualify for a waiver , youll also pay a 10% early withdrawal penalty if youre younger than 59½.
So, lets say youre 33 years old, and you have enough in your 401 to withdraw the $20,000 you need. Right off the top, unless you qualify for a waiver, you can expect to pay a $2,000 early withdrawal penalty. Then, when you file your income tax return, that 401 distribution will most likely be counted as ordinary income, so it will cost you even more. And if that added income bumps you into another tax bracket, you could end up paying even more.
But taxes and penalties arent the only costs to consider when youre deciding whether to go the distribution route.
Since compound interest creates the potential for your initial investment to grow significantly over time, every dollar you take out now could mean several dollars less in retirement. Essentially, withdrawing from your 401 now is like borrowing money from your future self, because youre losing long-term growth.
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What Are Some Ways Of Minimizing Risks To Your Retirement
If you decide using a 401 to pay off debt is your best option, here are a few things that could help you lower your financial risk.
Not using your high-interest credit cards once you use your 401 to pay them off. If you continue to use your credit cards, and then have credit cards and the 401 loan payments to make every month, you could end up in even more financial trouble.
Continuing to make contributions to your 401 while youre repaying the loan at least enough to get your employers match.
Not overborrowing. Creating a budget could help you determine how much you can comfortably pay each quarter while staying on track with other goals. And try to stick to taking only the amount you really need to dump your debt and no more.
When Does It Make Sense To Prepay Your Mortgage
If you have the money to prepay your mortgage in a lump sum, consider these points before writing that big check:
- After-tax opportunity cost. Consider the after-tax cost of money. As I mentioned in the example, a 5% mortgage loan actually costs you only 3.5% on an after-tax basis if you have a combined marginal income tax bracket of 30% . Can you do as well or better with an alternative use of your moneyrisk-free?
- Liquidity preference. If you have a low-rate mortgage, you might prefer to keep this money liquid. It might also be a question of keeping your money diversified.
- Income tax considerations. Remember, you can deduct the interest on mortgage debt of up to $1.1 million on your primary and/or secondary residence for purchase or capital improvement. Once youve paid off the original mortgage, youll be limited to the $100,000 home equity debt ceiling unless you make capital improvements or buy another home.
- Psychological considerations. Does your desire to be debt-free trump these other considerations? If so, put your peace of mind first and make the big payment.
Part II: Getting Closer: Transitioning into Retirement, Question 13
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Should I Pay Off Student Loans Or Invest My Money
If you are considering enrolling in such a program, it may not make sense to make additional payments to pay off the student loans faster. After all, you can just as well use that money by investing. And when you invest, you get a head start on your retirement savings. Even if you are overdue with your student debt.
How Much Can You Borrow
Plans can set their own limits for how much participants can borrow, but the IRS establishes a maximum allowable amount. If your plan permits loans, you can typically borrow $10,000 or 50% of your vested account balance, whichever is greater, but not more than $50,000.
But the CARES Act provides some exceptions to that limit. The law allows those who qualify to borrow up to $100,000 loans from your plan) or 100% of your vested account balance, whichever is less. That provision expires on Sept. 22, 2020.
To qualify, you likely need to fall within at least one of several scenarios, including
- You, your spouse or a dependent is diagnosed with COVID-19
- You experience financial hardship as a result of being quarantined, furloughed or laid off, or your hours are reduced because of COVID-19
- You cant work and are experiencing financial hardship because the COVID-19 crisis has cut off your access to childcare
- You have financial troubles because a business you operate or work for closes or reduces its hours as a result of COVID-19
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Should I Withdraw Money From My Ira To Pay Off Debt
Whether or not you should make an early withdrawal from your IRA depends on your unique situation. While its a viable option to pay off debt, there are some downsides. Many IRAs though not all have early withdrawal penalties, so you might not have access to as much funds as you think.
Even if your IRA doesnt have early withdrawal penalties, youll likely still have to pay income taxes on the amount you withdraw if youre under 59 and a half. Youll also lose access to funds you wouldve had for retirement even if you file for bankruptcy.
Leave Your Retirement Savings Alone
Raiding a retirement account might help you pay off debt quickly, but it could set the stage for financial ruin once you’re older, not to mention cost you money in the form of early withdrawal penalties. You’re far better off cutting back on expenses, boosting your earnings, and managing cash influxes wisely to chip away at that debt until it’s gone.
One more thing — if you can make your debt more affordable, it’ll be easier to pay off, so to this end, see if it makes sense to refinance. You can refinance your credit card debt by rolling it into a new loan, or transferring your balances to a new credit card with a lower interest rate. Both options will lessen the amount of interest you pay and hopefully help you shake that debt sooner rather than later.
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