Is Using Money From Your 401K To Pay Off Debt A Wise Choice?
I’ve had several people ask me recently if it’s a wise move to withdraw money from their 401k to use to pay off credit card debt. So let’s look at some of the pros and cons…
The first thing you need to consider is the fact that you’ll have to pay income tax on the money you withdraw, as well as a penalty in some cases. So you could be “losing” 25-30% right off the bat, before you receive any of the money yourself.
The next thing to consider is the long-term affect of withdrawing money from your 401k. With all the turmoil in the stock markets over the last two or three weeks, this is a good example of how withdrawing money can hurt you.
If your 401k is invested heavily in stocks, you would likely have lost a considerable amount over the last couple of weeks. When the 401k fund managers invested your money, the stocks would have been worth more than they are today. So if you withdraw that money now, you’ve permanently lost the value of the losses.
If you leave that money in the 401k, the stock market will more than likely rebound over the longer term (5-10 years) so while the value is down now, it will probably make back most if not all of that loss. This is assuming that you are not right on the verge of retiring, mind you. If you have more than 10 years to go to retirement, the odds are good that you’ll make back what you lost.
Now, let’s look at when it might be a good idea to use 401k money to pay off debt.
If you’re earning less on your 401k than you’re paying in interest on your debt, it might be a better choice to “invest” that money in yourself and pay off the debt. But it all comes down to timing. If you had withdrawn the money to pay off the debt the week before the markets took a tumble, you could have actually come out ahead.
But as I already pointed out, when the market is at a low point it’s not a wise choice to remove money because you’re basically “locking in” your losses.
So the bottom line is that it’s rarely a good idea to withdraw money from your 401k to pay off debt. The only time I would recommend it is if it’s a life-and-death situation or if you’re facing serious consequences, such as foreclosure, and that is the only money that you have available to you.
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