Should you Cash Out your Retirement Fund to Pay Off Debts?
When your debt problems are spiraling out of control, at a certain point of time, you might feel a strong urge to withdraw a portion of your 401k account money to pay off your current credit card debts. And the temptations tend to get stronger when you see that you can borrow money from your own pension account at an astonishingly lower interest rate.
However, deep down inside your sub-conscious mind, the question might arise, “Is it worth sacrificing your old age protection and perhaps the little money that you would like to convey to your children as an inheritance, for credit card debt settlement?”
In short, the answer is no, it isn’t.
• Ideally, a retirement fund should be withdrawn and employed only after retirement. There are a number of reasons why tapping into a premature retirement fund is a bad idea. The most obvious is that your retirement account is tax deferred. While you put in funds, you pay no taxes on them. However, when you withdraw money from your pension account, you must pay the tax on it. In fact, in many cases, if you make early withdrawal, you also have to pay heavy penalty for it. Taxes + Penalty = A bad idea. • Withdrawal of money from a pension account often requires compliance with a number of conditions. Most of the time, if you are unable to repay the withdrawn amount within 5 years of withdrawal, a huge penalty will be charged. It also means you may not be able to retire until you pay back the debt in full. And if you get laid off within this period, it can put your finances in jeopardy.
• Premature withdrawal of pension fund before you reach 60 years of age can bring severe consequences. If you fail to repay your borrowed amount within 5 years from withdrawal, the borrowed amount will be treated as a distribution and will be taxed based on your current income.
So, the bottom line is that it’s simply not wise to take away money from your retirement accounts to pay off your debts. However, there might be a few exceptions.
Remember, sometimes drastic situations require drastic measures. If you cannot manage your monthly bills, despite taking a second job, cutting your expenses to the bone and liquidating your non-retirement assets, you can consider going the retirement liquidation route. It means, under extreme situations, while you are carrying an unwieldy level of credit card debt and heading straight towards bankruptcy, liquidation of your retirement saving does makes sense.
Under what circumstances you might consider an early withdrawal of your retirement money:
• When your survival is at stake and you cannot bear the minimum cost of necessary expenses, such as food and utilities due to current debt loads. • When you have already exhausted all other assets in a financial impediment. • When you’re paying more in interest on debt than you’re earning on your retirement assets.
Keep the aforementioned points in mind and preferably attempt to avoid early withdrawal of your retirement account as long as possible.
Written by Kris Miller and Special Guest Blogger Sidney Terrell