Your retirement savings are there to help you get through what could be decades of reduced income, so it’s usually not a good idea to tap into them before you need to. This holds true even if you have a lot of credit card debt that you need to reduce.
Credit card annual percentage rates (APRs) have reached record highs in recent years due to rising interest rates, but as with any rule, there are always exceptions.
You should know the potential consequences before withdrawing money from your 401(k), IRA, or any other retirement account to settle your credit card bills. The most significant danger is having to pay a federal income tax of 20% on top of a 10% penalty if you cash out your retirement account before a certain age.
People with retirement accounts like 401(k)s and IRAs have until age 5912 to cash out. You’ll likely incur a fee if you withdraw money from your account before that time. The total cost of penalties and taxes could be almost as much as the original credit card balance. Let’s say you’ve run up a credit card bill of $15,000. After factoring in the penalty and tax, the minimum withdrawal, in this case, is close to $24,000.
You still have to pay taxes to withdraw money penalty-free, even if you’re of age. If you reduce the retirement savings, you risk losing out on investment gains. As a general rule, the more money you have in an investment account during rising stock markets, you will earn.
Since markets have been falling steadily for the past year, that is less of a concern today. Instead of letting your retirement savings sit idle, you may want to place focus on paying off your high-interest credit card debt.
It May Be Time To Put Retirement On Hold Funding Towards Debt Repayment
Paying off credit card debt doesn’t necessitate tapping into your 401(k) or individual retirement account. You can also stop paying them until the debt is paid off. The absence of a monetary penalty or an increase in your tax bill makes this option preferable. Paying off debt free will allow you to resume retirement planning.
Suspending contributions is an option, but it’s not ideal because you risk missing out on the employer match during that time.
Alternatively, you could borrow money from your retirement account and use the funds to settle your debt. Participants can take out loans from their 401(k), 403(b), or 457(f) plans, but IRAs and IRA-based plans like SEP, SIMPLE, and SARSEP are prohibited from doing so.
To get a loan from the plan, you must apply for it, and then the loan must meet some criteria. The plan’s administrator will send you details on how to apply for a loan and what terms you’ll be offered.
The American Association of Retired Persons (AARP) suggests considering this type of loan if you are still gainfully employed and can afford to repay the money to yourself without incurring any taxes. If you’re thinking about using a 401(k) loan to settle your credit card bills, here are a few guidelines to keep in mind:
Make a repayment plan that lasts up to three years, and you should feel confident that you will stay with the same company for three years.