4 Reasons You Should Not Use Your 401k to Pay Off Your Credit Card

by Joe Plemon on June 19, 2012

Q:  We have $30,000 in credit card debt and it seems it will take forever to get it paid off.  Should I use money from my 401(k) to pay off that debt?  I am 35 years old.

A:  I realize, when you see that money sitting in your 401(k), that there is a temptation to tap into it so you can make that credit card debt disappear.  I also realize that it seems to take forever to make progress on your credit cards, especially if all you are paying is minimum payment.  But using your 401k money to pay off credit card debt is not a good option for several reasons.  Here are four:
Use 401k to pay off credit cad debt

1. Taxes and penalties.

Because a 401(k) is a pretaxed investment, you were able to save taxes for all of those donations.  However, your Uncle Sam keeps records and will want his money back whenever you decide to tap into them.   Also, because you are younger than 59 1/2 years old, you will be required to pay a 10% penalty on whatever amount you take.  So, the taxes (about 25%) and the penalty (10%) would cost you $46,000 to pay off the $30,000 credit card debt.  It is like paying 35% interest on a loan.  Bad idea.

2. Money Stops Working For You

But it is really worse than that because now the money would not be working for you.  That $46,000 used to pay off $30,000 worth of debt could potentially be worth over a million dollars in 30 years.  You have worked hard and sacrificed in order to build up your 401(k), so don’t compromise your retirement over a credit card debt.

3. You wouldn’t be dealing with the real problem.

You need to ask yourself, “Why do I have this credit card debt?”  Whatever behaviors created the debt need to be eradicated from your life and you need to go forward with a resolve to never go back.

4. You need to attack the credit card debt.

Yes, this will take time, but once you develop a plan, you will be surprised at how much progress you can make.   These tips will help:

  1. Budget Time. You must create a personal budget so you can understand your cash flow and find ways to make extra payments on your credit card debt.
  2. Stop Contributing. Until you are out of debt, you should temporarily stop your 401k retirement investing or at least cut back to the minimum amount you can invest in order to get your company match.  Think about it:  keeping debt around while you are investing is the same as borrowing money to invest with.  Once your debt is gone you will have more money than ever to invest.
  3. Get a second job.  This is not for the rest of your life, just long enough to pay off your debt.  If your minimum payments on your credit card debt are currently $1,000 a month, an extra $1,000 a month will all go toward the principle and will drastically reduce the time it will take to get it paid off.
  4. Set a time goal.  If you follow these first three tips, it is not out of reason to see that credit card debt disappear in 12 to 18 months.

Creative Commons License photo credit: cncpt

The most important thing you can do is to change the habits that created the credit card debt.  Don’t sacrifice your future for a quick fix.  Instead, make huge sacrifices now and use a budget planner so you can get this debt out of your life forever.

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