Recently on our legal forum a user asked, “I have two 401(K) accounts. Both accounts have about $50,000 in them. I have about $50,000 in credit card debts. I have tried everything to lower my balances, but I am not making any progress. I am wondering if it makes sense to liquidate my retirement accounts and pay my credit cards off. I know there are some penalties in early withdrawals and some tax implications. What do you think?”
When do I use retirement savings to repay debts?
Given that every financial situation is a bit different, it’s important to review your financial issues with an expert financial planner. You might also want to discuss the tax implications with a tax attorney or a CPA.
After you have had this meeting you will need to review whether the funds can actually be withdrawn from your account, the tax liability if you do decide to deduct the funds, and how the withdrawal might impact your retirement balance.
- Review all alternative methods to lower your debts.
As part of your discussion with your financial planner you will need to review other alternatives you to reduce or eliminate your debts. For example, have you talked to every creditor and tried to negotiate a lower interest rate or different payment plan? Have you tried to transfer the balances of your accounts to other credit cards with a lower interest rate? Have you discussed the option of consolidating your loans and getting a better interest rate? If you have not taken these steps it’s not time to liquidate your 401k.
- Determine whether your funds can be liquidated.
After reviewing your alternatives to debt repayment determine whether your retirement plan allows you to withdraw your funds. If you cannot make a withdrawal than the whole discussion is moot. For example, funds contributed by your employer may have restrictions for withdrawal. Other plans may completely limit your withdrawal options or only allow withdrawals for hardship situations. Talk to your plan administrator.
- Review the tax penalties for early withdrawal.
A 10% penalty will be incurred if you withdraw your money early from your 401k. Additionally, you will also have to pay federal income tax, which could vary based on your tax bracket and the amount of your taxable income after your distribution. Consider also, this money has to be paid all at one time, which could be a challenge.
So when should you liquidate your 401k savings account? The answer is not the same for everyone. In some cases, if you have a very high interest loan and you can afford to pay the tax and penalty distributions, it might make sense. In other cases, however, there are better ways to repay the debt than withdrawing the money, especially if you are close to retirement and do not have the opportunity to rebuild your retirement savings.
With that in mind, most financial experts offer serious warnings about using your retirement savings as another checking or savings account and withdrawing money on a whim.
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