Answer: You don’t say how old you are, how much you’ve saved for retirement already or what your other debts are. All those factors help determine where your savings should go.

You’re smart to be contributing to a 401(k) and getting the full company match. You can use an online retirement calculator, like the one at ChooseToSave.org, to see if you’re saving enough. If you’re not, you can boost your contributions.

If you’re on track for retirement, the next step is to pay off any toxic debt such as credit cards. (Toxic debt is any debt that carries high or variable rates and that erodes, rather than enhances, your wealth.) Once that’s paid off, you can focus on building up your emergency fund. In general, it’s smart to have at least three months’ worth of expenses in a savings account to be tapped in case of real emergency, such as a job loss.

Answer: At that age, you wouldn’t face tax penalties for early withdrawal and you’re probably giving up less in future gains than someone who is younger.

But dipping into a 401(k) to pay unsecured debts may still be a bad move if there is any chance you’ll wind up in Bankruptcy Court, because retirement funds are protected from creditors. It’s also unwise if you would be withdrawing a large part of your nest egg, because this money has to last you the rest of your life.

A visit with a fee-only planner can help you decide whether using your retirement money this way makes sense. You can get referrals from www.garrettplanningnetwork.com or www.napfa.org.

Answer: Why do you think premature withdrawals from retirement funds are so heavily penalized? And why do you suppose retirement funds are protected from creditors in Bankruptcy Court?

It’s because lawmakers have decided that there are some things worse than reneging on your debts, and one of them is an impoverished old age.

Yes, if you take on a debt, you should do your utmost to pay it back out of your current income. If you need to sell otherwise-unprotected assets to do so, then do so.

But tapping retirement funds prematurely is rarely smart, and it’s particularly unwise if there’s a possibility that you’ll wind up in Bankruptcy Court. Advising people of that fact is a long way from encouraging them to file for bankruptcy.

By the way, few people who have been through it would call bankruptcy an “easy way out.” Many people struggle with the decision, put off filing for too long and drain the very resources that could have been protected, only to end up having to throw in the towel anyway.

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.

You’ll have to pay regular income taxes on that money, but you won’t otherwise be penalized for trying to be aggressive about your retirement savings.

photo credit: Daniel Greene

I’m getting to this good news a little late, but it’s still worth noting. Fidelity Investments reported last month that more workers increased the amount of money they put into their 401(k) accounts during the second quarter than decreased their contributions. In the three months ended June 30, 4.7% boosted their contributions, with just 3% decreasing it.

That was a switch from the previous three quarters, when workers with decreasing contributions had outnumbered those raising them. In those earlier quarters, over 6% of participants cut their contributions.

Note that we’re talking about changes made on the margins, since the vast majority of 401(k) contributors don’t make any changes month to month or even year to year. And that’s a good thing. Those who keep on investing in good years and bad will ultimately make more money than those who try to time the markets.

Maybe it’s time to look at your own 401(k) contribution rate and see if you might be able to boost it a percentage point or two. If you need some inspiration, use MSN’s Retirement Planner to see how much you should be saving.

Other findings from Fidelity:

• The average 401(k) account balance rose 13.5 percent in the second quarter from the end of the first quarter in 2009 to $53,900. The increase was primarily driven by increases in the stock markets as well as worker and employer contributions.
• About 68 percent of the money contributed to 401(k)s  went to stocks, which is down from 75 percent in the past few years and a high of more than 80 percent in 2000.
• About 42 percent of contributions went to domestic and international stocks; 24 percent to blended or lifecycle investments; 8 percent to company stock; 24 percent to conservative investments, such as money markets and fixed-income assets.

Need more info? Check out some of my advice on saving and retirement:

• How to retire in bad times
• No 401(k) match? Save anyway
• Under 35? Hurray for the meltdown!

Answer: Take a deep breath. There are a few steps involved, but this isn’t rocket science.

First of all, understand that you may not need to do anything with the money. Some employers allow you to keep your money in their plans even after you leave, although others will require you to move it. Call your former company’s human resources department and ask about your options.

If you are required to move the money, you’re correct that the money should transferred directly to an individual retirement account custodian, which can be any bank, brokerage or mutual fund company that offers IRAs.

You want to transfer the money directly so that 20% of the money isn’t withheld for taxes.

Any IRA custodian you contact will help you with the paperwork and the transfer. Consider contacting a discount brokerage or mutual fund company, since these tend to charge lower fees than banks and full-service brokerages. Some companies to check out include The Vanguard Group, Fidelity Investments and T. Rowe Price.

No matter what, “the losses workers have sustained are so extraordinary, they’ll need to be much more proactive about saving to build their nest egg back up to pre-recession levels,” says Pamela Hess, director of retirement research at Hewitt Associates.

Here are some of the study’s key findings:

• The median rate of return in 2008 for 401(k) plans was a 28.3% loss—with the average 401(k) balance dropping from $79,600 in 2007 to $57,200 at the end of last year.
• Only 11% of employees were able to break even or gain in their 401(k) portfolios. Forty-four percent of employees lost 30% or more of their savings in 2008.
• 74% of employees participated in their 401(k) plan in 2008, which is consistent with previous years’ findings.
• The average 401(k) contribution rate dropped only marginally, from 7.7% in 2007 to 7.4% in 2008. Just 5% stopped contributing to their 401(k) plan altogether in 2008.
• There was a slight increase in the number of workers who made any trade in their 401(k) plan last year: 19.6% in 2008 vs. 18.7% in 2007.
• Nine of the ten most active trading days were the day after a large downturn in the market, or days with an average return of -4%.
• Employees’ average equity exposure dropped to just 59% in 2008—which is an all-time low since Hewitt began tracking it in 1997. Stable-value funds—which are considered less risky investments—experienced an 11% increase in asset allocation in 2008.
• 18% of employees took a hardship withdrawal from their 401(k) plan in 2008. The number of employees taking out 401(k) loans (23.1%) in 2008 remained similar to levels in prior years.

For more advice of investing, check out my columns below:

• 5 life lessons from the recession
  

• Under 35? Hurray for the meltdown!

• What’s the best way to reduce risk as I approach retirement?

Answer: Of course not. Using retirement money to pay off debt is stupid on a number of levels.

The 20% that’s withheld when you prematurely withdraw money from a 401(k) often isn’t enough to cover the actual tax bill. You’ll pay taxes at your regular federal and state income tax rates on the money, plus penalties. (The federal penalty is 10%, plus whatever penalty your state adds.) Even if you’re in the 15% tax bracket, you’ll have to pay taxes equal to more than a third of the money you withdraw. At higher tax brackets, you could lose half or more of the money you take out.

Once the money is withdrawn, you can’t put it back. That means you lose all the future tax-deferred gains the money could have earned. Assuming an average 8% annual return over 30 years — and the stock market has achieved that, even counting in the years of the Great Depression — you’ll wind up losing $10,000 or more in retirement money for every $1,000 you withdraw now.

Furthermore, money in a retirement account is protected from creditors should you wind up in bankruptcy. Before you use protected money to pay off a debt that could be erased in a bankruptcy filing, you should talk to an experienced bankruptcy attorney.

We are in our early 40s and have accumulated about $250,000 in my 401(k). Our primary home has about 10 years left on a 15-year mortgage, so that will be with us for a while yet. Can you offer some advice?

Answer: Typically, the worse thing you can do with a 401(k) is to fail to contribute to it. The second worst thing is to prematurely withdraw the money you’ve accumulated.

Let’s review. Your $15,000 withdrawal is subject to regular income taxes plus federal and state penalties that could easily consume $5,000 to $7,000 of your withdrawal. What’s worse, though, is that the money you withdraw won’t continue to grow tax deferred. In 25 years, that $15,000 could easily grow to $100,000, assuming an 8% average annual return (which is a reasonable long-term assumption for a balanced portfolio of stocks and bonds).

A loan from your 401(k) isn’t necessarily a better option. If you lose your job — and the troubles at your company make that a possibility — you may have trouble paying the loan back quickly, which typically you must do to avoid having it treated as a withdrawal.

Besides, credit card debt is short-term debt that should be repaid with current income whenever possible. Turning it into a longer-term debt doesn’t solve your spending problem and could end up costing you more interest.

You’re grasping for a quick fix to an entrenched problem. What you really need to do is get realistic about your situation. Stop using the credit cards as a stopgap. Start making the more painful cuts in your budget to get your spending in line with your current income and debt repayment needs. You can find suggestions for trimming expenses on websites such as Dollar Stretcher (www.stretcher.com) or in books such as Amy Dacyczyn’s “Tightwad Gazette.”

A second income could help enormously here. So could selling possessions you no longer need at a yard sale, a consignment shop or an online outlet such as EBay.

Also, you might consider refinancing that 15-year mortgage to a longer-term loan. A 30-year mortgage in today’s low-interest-rate environment would significantly reduce your monthly expenses, and you could always accelerate your payments should your income increase.

Raiding a retirement account should be an absolute last resort, and you’re a long, long way from having run out of other options.