Questions And Answers About Debt Reduction - Should I Cash Out My 401(k) To Pay Off Debt

Mar 14 2008

Posted by NCN as Debt Reduction, Noted |

Should I Cash Out My 401(k) To Pay Off Debt?

Under most circumstances, if you cash out your 401(k), you will have to pay federal, state, and local income tax.

You will also owe an early withdrawal penalty - 10% - if you are under the age of 59 1/2.

In almost every case, for every $100 dollars you withdraw, you will pay between $25 and $50 dollars in taxes and penalties.

In other words, unless you are doing so to avoid bankruptcy, it’s a bad idea to cash out your 401(k) and pay off debt.

Instead, live on a budget, reduce spending, and create a debt snowball. Stop looking for ‘quick fixes’ and learn to ‘do the work’.

Finally, if you cash out your 401(k), you lose years of ‘compounding power’. To see how important ‘compounding’ is, check out this chart.

Over the next few weeks, I’ll post more ‘Questions And Answers About Debt Reduction’.

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For in depth information about this topic (and similar questions), check out these articles from my fellow members of the Money Blog Network -

Can you cash out Roth IRA to pay off house? (Five Cent Nickel)

Should you borrow money from your 401(k)? (Consumerism Commentary)

How much will a 401(k) loan cost you? (All Financial Matters)

Your 401(k) is not an ‘investment’ (Wise Bread)

Don’t Kill Your Retirement Fund When You Change Jobs (Free Money Finance)

How Strong Is Your Piggy Bank? (Mighty Bargain Hunter)

Three Popular (But Dumb) Money Moves (Get Rich Slowly)

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5 Responses

Get Out of Debt Squirrel

March 14th, 2008 at 11:11 am
1

One other point to consider is that while the stock market is in the toilet right now, it will go back up. Every dollar you withdraw from your 401 now, will not make a return for you latter.

For example, let’s say in the next five years the stock market goes up 20% from where it is now. So the cash out will cost you 20% plus the penalties mentioned above. If you borrow from your 401 it will cost you say a 5% rate to repay your 401 loan plus the lost return of 20%.

The promise to put the money back will still not result in the same return as if you leave the money in.
tlange

March 14th, 2008 at 6:35 pm
2

What do you do if you stand to inherit a non-spousal 401k/403b? I think the rules are different with those?
MoneyBlogga

March 14th, 2008 at 7:27 pm
3

I am sick as I read your article today. I knew my financial devil-may-care attitude was costing me but, until I saw that 401K compounding chart, I didn’t know just how much. Now I feel sick. And STUPID. Very very stupid.
AJC @ 7million7years

March 16th, 2008 at 2:23 pm
4

As somebody ‘on the other side’ of the getting-financially-free journey, here is what I suggest:

1. Keep your money in 401k AND keep contributing but only up to employer match

2. Save inside/outside of 401k at least 10% - 20% of CURRENT income

3. Save outside of 401k at least 50% of any FUTURE additional income i.e. payrises, excess business profits, tax refund checks.

4. INVEST the proceeds of 2. and 3. into: your own home then into rental real-estate and/or direct stocks (4 or 5 undervalued companies … there are plenty around right now) and/or low-cost Index Funds

5. Repeat until Rich (prob. 10 - 30 years)!
financial wellness project

August 29th, 2008 at 4:51 pm
5

great points about not looking for quick fixes and doing the work. however, i am currently in a conundrum as i have been considering raiding my ira these past few weeks..