I don’t know anyone who likes having heavy credit card debt. It hangs over consumers like a dark cloud affecting every spending decision they make and causing constant stress.
And it’s even worse if the credit card kicks in a high interest rate, which they commonly do. Consumers often end up paying between 19 and 29 percent interest on the balance. At those rates it can be difficult to ever pay it off.
It’s no wonder that some people consider tapping their retirement accounts—such as a 401(k), 403(b), IRA or similar version—to pay off their expensive credit cards.
To some it’s a logical decision: you’re thousands of dollars in debt, paying astronomical interest rates on the balance, barely able to make the minimum monthly payment and looking at carrying debt forever. Yet, there sits a retirement account with ample funds that could easily cover the credit card balance.
It’s tempting: use those retirement funds to pay off those credit cards and be done with them once and for all.
But it may be a mistake, and in many cases it doesn’t work.
Withdrawing money from your retirement account can be costly and paying off your debt may not actually reduce monthly payments by enough to solve the problem. As a result you could end up worse off for having used retirement funds and not solving the problem.
When you withdraw money from your retirement account you are losing much more than just the amount you take out. For one thing, by reducing the amount of that account you are losing valuable purchasing power and forfeiting all the interest that money would have earned over the years. That can be a substantial amount.
And if you withdraw before you are eligible (at age 59 ½ with some exceptions), you are likely to receive 30 percent less after penalties and taxes.
That’s right: be sure to consider the tax burden that early retirement fund withdrawal will incur. Unless you have a Roth IRA, regular income taxes will be assessed on all retirement fund withdrawals.
Of course, there may be some legitimate reasons and scenarios in which it is prudent to make early retirement fund withdrawals.
Often, for people who lose their job for various reasons, the retirement fund comes on the table as a consideration of living income. And in some cases, retirement funds may offer a loan option, such as for first-time homebuyers, in which you borrow from your fund (borrowing from yourself, in effect) and pay it back over time.
But because there is likely a heavy penalty, taking money out of your retirement fund should be considered a last resort, reserved for emergencies.
There are better solutions for people carrying high-interest credit card balances and they don’t involve bankruptcy, debt settlement or consolidation.
Of course every situation is different and no single debt solution applies to all consumers. But a good place to start is a consultation with a debt or credit counselor, of which there is a large variety available.
A reputable debt counselor can help you devise a realistic plan for paying off your credit card and other debt without resorting to dire measures, as well as assisting with a solid budget and savings strategies to avoid unnecessary debt in the future.
For advice and information on finding a credit counselor, you might check the Federal Trade Commission website, www.ftc.gov.
When seeking out debt or credit counseling, whenever possible try to find someone local or within your area so that you can meet in person. And be sure to shop around. In the world of debt counseling there are a lot of scams looking to prey on the vulnerable.
At the very least, be sure to consult with a debt counselor before touching that retirement account. With most debt counseling services—including PowerDownDebt—the first consultation is free.