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Dear Liz: I have almost $250,000 in my retirement accounts. I also have almost $50,000 in credit card debt. Should I take $50,000 from my 401(k) to pay off the debt?

Answer: No, no, no.

In case that wasn’t clear: No.

Of all the dumb financial moves you can make, raiding retirement funds to pay off credit card debt ranks near the top. You’ll pay penalties and taxes that typically equal one-quarter to one-half of any withdrawal, plus you lose the future tax-deferred returns that money could make. If you’re 30 years from retirement, that $50,000 withdrawal would cost you $500,000 in lost retirement income, assuming an 8% average annual return.

The fact that you have that much debt puts you at high risk of bankruptcy. In bankruptcy, your unsecured debt can be wiped out or reduced, while your retirement funds would be protected from creditors.

If you can’t figure a way to pay off your debt without raiding your retirement, you need to make two appointments: one with a legitimate credit counselor (visit the National Foundation for Credit Counseling at www.nfcc.org) and another with a bankruptcy attorney.

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5 Comments

1

Wow, great info. My retirement account isn’t so well endowed, but I have been considering depleting it to eliminate about 40K in CC debt. Glad to know this is a bad move. I wonder about credit card (debt) settlement companies and the after effect.

2

Search “debt settlement” on MSN to find some articles about this, but debt settlement with original creditors can trash your credit scores and lead to lawsuits. It may be an option 1) if you can’t pay the debt yourself (best option), qualify for legitimate credit counseling (www.nfcc.org) (next best option) or file Chapter 7 bankruptcy.

3

An answer re: using 401(k) money to pay off credit cards is incomplete if you don’t include the obvious positive result of borrowing from your 401(k) to extinguish credit card debt. Replacing an 18% borrowing cost with one at prime (plus a small fee), with prime paid to oneself, is not only fiscally responsible, but will free up funds to increase retirement savings. The argument that repaymemnts of 401(k) borrowing are double taxed is a myth, since it ignores the fact that the loan is tax FREE.

4

If there’s no risk you’ll lose your job, or if the plan allows you to pay back the balance over time even if you do, then I’d agree a 401(k) loan may be an option to consider. Too many people aren’t in that enviable position, though, so they risk having the loan become an inadvertent withdrawal should they lose their jobs.

5

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