cash out 401k to pay off debt

dndminnich · Joined: 04 Aug 2007 Posts: 1 1.55 Dollars($)

I am 36yrs old. I have 34k in my 401k. I have 16k in debt I would like to pay off. I am falling behind in all payments. I will save about 700 a month in payments by eliminating this debt. I plan to retire when I am 65. I don't feel if I borrow from my 401k I will really save in my budget because the monthly payment it will take to repay will defeat the purpose. is it sometimes nessasary to cash out a 401k? I plan to max my contribution and I have a 50% company match. Also, getting into debt willnever be an option. I will keep about 7k in a savings at all times, this should eliminate a need to borrow and get into debt again.

miller_st · Joined: 17 Jan 2007 Posts: 917 168.82 Dollars($)

Hi Dndminnich,

You can borrow up to $50,000 or fifty percent of your account balance, whichever is less. This loan will have to be paid off within 5 yrs. & payment is to be made at least once in a quarter. And you will have to pay interest on it though the interest will go back into your own account. Here you are the lender as well as the borrower.

But if you are not able to make payments once in a quarter or pay off the loan within 5 years then a 10% penalty is accessed considering the loan as a distribution from your account. And the money becomes taxable income. So you need to keep these pitfalls in mind before considering borrowing from the account.

Miller

Guest 0.10 Dollars($)

I won't advice you to borrow from 401k.

The reason is you will be giving up tax free compounding of money that you will withdraw which can result in relatively smaller balance left at the time of retirement. And if you leave your current employer due to some reason then may have to immediately pay the loan back or face tax and penalty.

Guest 0.10 Dollars($)

Once I also thought about borrowing from 401k but my financial planner advised not to do so and look at all other options before selecting to borrow from 401k.

I would also recommend you not to borrow out of your retirement plan if other options are available.

dcrum0 · Joined: 18 Feb 2008 Posts: 19 10.17 Dollars($)

Yes, borrowing from your 401k is not a good idea, and you should NEVER cash out your 401k. It may sound tempting even with the penalty and taxes but it's not worth it.

You could always greatly reduce your 401k contributions and use the extra monthly fund from that to pay down debt quicker. I'm not sure how many hours your work now but you could always pick up a second job to help knock out the debt. Just some suggestions, Good Luck.

0.10 Dollars($)

I dont necessarily agree. Borrowing money from your savings is not all that bad, is that not what savings are for. Think about the state of many of american's 401K over the past few years. Returns have not been all that great, surely 10% or less in many occasions. The interest paid on a 401K Loan is 8.5% or so, much lower than that associated with credit card rates. The money you did borrow will return to your 401K as you pay it back and it will earn some interest. Additionally, the money that is paid back is generally taken directly from each paycheck. Therefore, if you budget accordingly it generally goes un-noticed. I am not a financial planner, yet I have borrowed from my 401K to pay off some deby that otherwise would have been difficult to overcome. I would definately not "cash in" your 401K, you will never save that money again, with the loan it is just that - a loan.

dcrum0 · Joined: 18 Feb 2008 Posts: 19 10.17 Dollars($)

I guess you make a valid point, but I still disagree with borrowing from your 401k. First, it's not real simple to get a loan against your 401k. Many times there are restrictions about borrowing from your retirement accounts. Also, if you are going to have the money to pay back the 401k loan then why not look into some type of consolidation loan or get a loan from a credit union which has a lower interest rate? I'm just not a fan of borrowing from your retirement accounts because it's not what they were designed for.

sara · Posted: Thu Mar 13, 2008 12:24 am Post subject: RE: borrowing from 401k

Well, borrowing from 401k may or may be a good option depending upon why one has to borrow and what's his financial situation. It is true that interest rates are lower than credit card rates but what about the taxes and penalty for cash withdrawn?

dcrum, a consolidation loan has a long term, so even if one makes payment on the loan at a lower rate of interest, in the long run he is actually paying a lot of interest.

I feel if one has to consolidate debts, he may go for debtconsolidation program or may be debt settlement.

Take Care

0.10 Dollars($)

Well first of all there was no penalty or charges for borrowing "my" money. Since this is a loan there were no tax implications. The payment is payroll deducted (post tax) so there is no tax burden on the loan. As for ease of borrowing, I suppose that depends on your company's plan. I applied for the loan on-line and had a bank check within 5 days. I only had to wait a couple of days for the check to clear at the bank.

All in all, pretty easy process. I do know that if you are borrowing from your 401K for purposes of home purchase, things are a little different (I presume because the interest may be tax deductible).

Either way, say you have 50K in 401K earning low interest due to economy at this time. You have 18K in debt at 21% interest and 400 / mo payments which do you nol good to paying down the debt. You borrow the 18K and pay it back in 5 years at 8% interest that goes into your 401K. The debt is paid off immediately and I would be willing to bet that your payroll deduction (at twice monthly) will be less than the previous $400 payment.

My suggestion, model the loan and evaluate your options. If you are secure in your job this may be a good alternative to paying bills late and being cashed strapped each month.

larry · Joined: 27 Jun 2007 Posts: 2951 411.26 Dollars($)

Hi Guest,

Welcome to the forum.

I think using 401k to pay off your debt is not a very intelligent idea. Because you must pay back the loan within 5 years. If you leave the job then the loan is payable straight away. If you do not make the payment and if you are under 59 year of age then it will be considered as the amount is distributed to you and you will have to pay additional 10% excise tax as a penalty for an early withdrawal of the 401k fund.

Feel free if you have any further questions.

Best of luck,
Larry

All times are GMT - 7 Hours

Page 1 of 1