{"id":1383,"date":"2016-04-18T08:00:47","date_gmt":"2016-04-18T13:00:47","guid":{"rendered":"http:\/\/www.investmentzen.com\/blog\/?p=1383"},"modified":"2017-05-22T14:58:26","modified_gmt":"2017-05-22T18:58:26","slug":"cashing-out-401k-to-pay-off-debt","status":"publish","type":"post","link":"https:\/\/www.investmentzen.com\/blog\/cashing-out-401k-to-pay-off-debt","title":{"rendered":"Is Cashing Out A 401k To Pay Off Debt A Good Idea?"},"content":{"rendered":"

I<\/span>f you\u2019re deep in debt and looking for a way out, it\u2019s smart to take stock of any and all resources at your disposal.<\/strong><\/p>\n

If you have expensive items you could sell, for example, you could throw that cash directly towards your debts. And if you have some money stashed away in savings already, you may be in even better shape.<\/p>\n

With average credit card rates sitting at 15 percent and savings accounts earning around 1%, you could pay down debt and save money in one fell swoop.<\/p>\n

But, what if you don\u2019t have savings or anything to sell?<\/em> If you start looking around and find your only asset is your retirement account, you\u2019ll want to think long and hard before going down that road.<\/p>\n

While paying off debt is an investment you\u2019ll certainly benefit from, borrowing the money from your 401(k) or any other retirement account is rarely a good move<\/strong>.<\/p>\n

To learn why, we interviewed several financial experts for their take. Here\u2019s what they said:<\/p>\n

Why You Should Keep Your 401(k) Intact<\/h2>\n

Cashing out your 401(k) to pay down debt can seem like a dream come true. You\u2019ve got debt on one hand and a huge chunk of money in the bank, so why not combine the two and create a new debt-free life? I mean, what could go wrong?<\/em><\/p>\n

Sadly, it isn\u2019t nearly that simple, which is why most people who choose this option live to regret it. At least, that\u2019s what financial planner Shannon McLay of The Financial Gym<\/a> has to say about it.<\/p>\n

According to McLay, many people who cash out their 401(k)\u2019s fail to consider the immediate financial costs of doing so. And when the details shake out, they aren\u2019t all that happy.<\/p>\n

Let\u2019s talk about penalties and taxes first, shall we?<\/p>\n

\u201cIf you are below 59 1\/2, you will have to pay a 10% penalty to cash out your 401(k),\u201d says McLay. Assuming you cash out $5,000, you will have to pay a $500 penalty, she says.<\/p>\n

But the pain doesn\u2019t end there, since you\u2019ll obviously need to pay income taxes on those funds as well.<\/p>\n

If your tax rate is 28%, that’s $1,400 in federal taxes, notes McLay, and then you will have to pay state taxes in addition to this.<\/p>\n

So, on the $5,000 you cashed out, you could fork more than $1,900 of it back right away.<\/p>\n

\u201cAt this point, you have essentially lost about half of your money in the taxes and penalties,\u201d notes McLay.<\/p>\n

Obviously these losses will be amplified if you cash out an even bigger chunk of your 401(k). Cashing out $20,000 if you\u2019re under age 59 \u00bd, for example, would result in a $2,000 penalty and $5,600 in federal taxes that year based on a 28% tax rate. Add in state taxes and you\u2019ll easily fork over somewhere around $8,000 of your $20,000 lump sum that first year.<\/p>\n

But the near-term financial consequences aren\u2019t the only worries you\u2019ll have, notes Caleb McElveen of the Saving Thousands Radio Network<\/a>. Cashing out your 401(k) has short-term consequences, yes, but it also comes with an opportunity cost.<\/p>\n

\u201cOnce you have cashed out those retirement funds and used them, you will never see that money again,\u201d says McElveen. \u201cThe money you have saved over time to help your financial future is no longer there.\u201d<\/p>\n

In addition to paying those taxes and penalties, you will miss out on the gains you could have earned<\/em> on that money, says McLay. \u201cIf you cash out $5,000 from your 401k and do not replace it, assuming a 5% return over 20 years, you will miss out on over $13,000,\u201d she says. \u201cAnd every year you delay replacing the money you took out is more lost investment income.\u201d<\/p>\n

The Real Problem with Cashing Out Your 401(k)<\/h2>\n

You heard it here first, folks. Cashing out your 401(k) could leave you with the worst result possible. Not only will you fork over a bundle in taxes and fees, but you\u2019ll forfeit some of your retirement savings as well.<\/p>\n

In that sense, cashing out your 401(k) is akin to robbing your present self and your future self \u2013 even if you planned to use those funds to pay down debt.<\/p>\n

Plus, cashing out your 401(k) doesn\u2019t get to the crux of the problem, either \u2013 as in, why were you in so much debt in the first place?<\/p>\n

If you find yourself in a position where the only way out of your debt is to cash in your 401(k), you have bigger financial problems that need rehabilitation anyway, says Benjamin S. Offit, CFP\u00ae of Clear Path Advisory<\/a>.<\/p>\n

In a lot of ways, paying off debt with your 401(k) can be a band-aid approach, he says. While paying off a huge chunk of debt might provide some temporary relief, the underlying issues that got you into debt aren\u2019t being handled.<\/p>\n

\u201cYou probably need to further explore you savings and spending infrastructure and discipline,\u201d says Offit.<\/p>\n

Alternatives to Raiding Your 401(k)<\/h2>\n

According to Drew Horter, founder and chief investment officer at Horter Investment Management<\/a>, taking a cursory look at your spending might reveal that you actually have the cash to pay down your debt yourself \u2013 and without touching your 401(k).<\/p>\n

\u201cAlternatives that can be considered for paying off debt can include taking on a second job and cutting back on discretionary expenses such as vacations, new cars or going out to eat,\u201d says Horter.<\/p>\n

By cutting all the \u201cextras\u201d out of your life, you might be able to come up with a plan to destroy your debt on your own. That may not be as sexy as plopping down a lump sum, but there are times when the best way to do something is the hard way.<\/em><\/strong><\/p>\n

If you can\u2019t find the funds to get out of debt on your own, McLay suggests an alternative approach \u2013 borrowing against your 401(k).<\/p>\n

\u201cThis keeps your money invested and protected from taxes,\u201d says McLay. While you will have to pay interest on your loan, 401(k) loans typically charge low interest rates. If you\u2019re carrying high interest debt, a low interest 401(k) loan might help you consolidate and pay down your debts faster.<\/p>\n

One other option to consider to pay down debt is a 0% balance transfer offer. Many banks offering this benefit will extend a 0% APR on transferred balances for anywhere from 12 to 21 months. While you might need to pay a balance transfer fee (usually 3-5% of your transferred balance) to take advantage, you can score 0% APR for an introductory period of at least one year. You can view a comparison of the best balance transfer credit cards here<\/a>.<\/p>\n

If you throw all of your extra funds at your debts during that time, you might be able to kill them once and for all. Better yet, you can avoid paying interest during the entire process – and your retirement account will remain intact.<\/p>\n

You can also consider consolidating and\/or refinancing your debt to ease your burden. Whether you actually get a benefit from refinancing will vary from situation to situation, but its worth looking into. A new generation of lenders like SoFi will look at factors outside of your FICO score to refinance your existing loans.<\/p>\n

You can get free no commitment quote from SoFi (along with a $100 welcome bonus) for student loan refinancing here<\/a>, or for general personal loans here<\/a>.<\/p>\n

Remember, using a 0% balance transfer offer, borrowing from your 401k, or refinancing your loans at a lower rate are all just band-aids for your debt problems – if you don’t address the root of the issue and make long-term changes to your financial habits, you’ll be right back where you started.<\/p>\n

The Bottom Line<\/h2>\n

While cashing out your 401(k) to pay down debt might solve a problem today, it could lead to years of worry down the line. Since you initially opened a 401(k) to save for the future<\/a>, it\u2019s important to keep that goal in mind for the long haul. You do want to retire one day, right?<\/p>\n

Robbing your future self to make your life easier today is the easy way out. If you truly want to get out of debt, you should look hard, and keep looking, until you find another way.<\/p>\n

Your 401(k) might look like a huge sum of money that could save the day, but it\u2019s much more than that. That money actually represents your future, and how you\u2019ll support yourself when you hit old age.<\/p>\n

No matter how enticing it looks, you\u2019re better off leaving it alone. Because, trust us, you\u2019re going to need it.<\/p>\n","protected":false},"excerpt":{"rendered":"

If you’re struggling with debt, it might be tempting to dip into the 401k cookie jar to relieve the pressure. But is it actually a sound financial move?<\/p>\n","protected":false},"author":11,"featured_media":1401,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_lmt_disableupdate":"","_lmt_disable":""},"categories":[90,94,57],"tags":[],"yoast_head":"\nIs Cashing Out A 401k To Pay Off Debt A Good Idea? - InvestmentZen<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/www.investmentzen.com\/blog\/cashing-out-401k-to-pay-off-debt\" \/>\n<meta name=\"twitter:label1\" content=\"Written by\" \/>\n\t<meta name=\"twitter:data1\" content=\"Holly Johnson\" \/>\n\t<meta name=\"twitter:label2\" content=\"Est. reading time\" \/>\n\t<meta name=\"twitter:data2\" content=\"7 minutes\" \/>\n<script type=\"application\/ld+json\" class=\"yoast-schema-graph\">{\"@context\":\"https:\/\/schema.org\",\"@graph\":[{\"@type\":\"WebPage\",\"@id\":\"https:\/\/www.investmentzen.com\/blog\/cashing-out-401k-to-pay-off-debt\",\"url\":\"https:\/\/www.investmentzen.com\/blog\/cashing-out-401k-to-pay-off-debt\",\"name\":\"Is Cashing Out A 401k To Pay Off Debt A Good Idea? - InvestmentZen\",\"isPartOf\":{\"@id\":\"https:\/\/www.investmentzen.com\/blog\/#website\"},\"datePublished\":\"2016-04-18T13:00:47+00:00\",\"dateModified\":\"2017-05-22T18:58:26+00:00\",\"author\":{\"@id\":\"https:\/\/www.investmentzen.com\/blog\/#\/schema\/person\/d7f36628b0696b9981f40e755bf0d2e8\"},\"breadcrumb\":{\"@id\":\"https:\/\/www.investmentzen.com\/blog\/cashing-out-401k-to-pay-off-debt#breadcrumb\"},\"inLanguage\":\"en-US\",\"potentialAction\":[{\"@type\":\"ReadAction\",\"target\":[\"https:\/\/www.investmentzen.com\/blog\/cashing-out-401k-to-pay-off-debt\"]}]},{\"@type\":\"BreadcrumbList\",\"@id\":\"https:\/\/www.investmentzen.com\/blog\/cashing-out-401k-to-pay-off-debt#breadcrumb\",\"itemListElement\":[{\"@type\":\"ListItem\",\"position\":1,\"name\":\"Home\",\"item\":\"https:\/\/www.investmentzen.com\/blog\/\"},{\"@type\":\"ListItem\",\"position\":2,\"name\":\"Loans\",\"item\":\"https:\/\/www.investmentzen.com\/blog\/topics\/loans\"},{\"@type\":\"ListItem\",\"position\":3,\"name\":\"Paying Off Debt\"}]},{\"@type\":\"WebSite\",\"@id\":\"https:\/\/www.investmentzen.com\/blog\/#website\",\"url\":\"https:\/\/www.investmentzen.com\/blog\/\",\"name\":\"InvestmentZen\",\"description\":\"\",\"potentialAction\":[{\"@type\":\"SearchAction\",\"target\":{\"@type\":\"EntryPoint\",\"urlTemplate\":\"https:\/\/www.investmentzen.com\/blog\/?s={search_term_string}\"},\"query-input\":\"required name=search_term_string\"}],\"inLanguage\":\"en-US\"},{\"@type\":\"Person\",\"@id\":\"https:\/\/www.investmentzen.com\/blog\/#\/schema\/person\/d7f36628b0696b9981f40e755bf0d2e8\",\"name\":\"Holly Johnson\",\"image\":{\"@type\":\"ImageObject\",\"inLanguage\":\"en-US\",\"@id\":\"https:\/\/www.investmentzen.com\/blog\/#\/schema\/person\/image\/\",\"url\":\"https:\/\/secure.gravatar.com\/avatar\/b0d295f9857bcc5e3800911570a7fa20?s=96&d=mm&r=g\",\"contentUrl\":\"https:\/\/secure.gravatar.com\/avatar\/b0d295f9857bcc5e3800911570a7fa20?s=96&d=mm&r=g\",\"caption\":\"Holly Johnson\"},\"description\":\"Holly Johnson is a nationally recognized financial expert and award-winning writer whose obsession with frugality, budgeting, and travel plays a central role in her work. 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