Should you use your retirement savings to pay off debt?
If you’re planning to use your retirement funds to pay off pesky debts, you must think twice. Taking out a 401(k) loan may sound attractive for a couple of reasons and those are,
• You don’t have to meet any qualifying criteria
• You can get access to quick fund
• Interest charged on such loans are much low – 4% to 5%
Such plans usually allow you to take out 50% of your balance up to 50,000 USD that you must pay off along with interests through automated payroll deductions. You will have five years in hand to pay back your loan.
According to a recent survey by TIAA-CREF, almost 50% retirement savers who took 401 (k) loan said that they borrowed the money to slash debt. Be it a mortgage debt, credit card debt or retirement debt – it appears from the survey report that borrowing from 401 (k) is a good and easy option to pay back any type of outstanding debts.
• You will raid your current savings.
• You will miss out the compound interest that you would gain over time through those funds.
• Like any other type of borrowing, a loan from 401 (k) plans is not tax free. You will need to pay the loan off with after-tax dollars and then again pay taxes when you will withdraw your money after retirement. Therefore, you will have to pay taxes twice.
• If you lose present employment or switch to a new job, the repayment time for the loan will shrink to as little as only 60 days. And if you fail to meet the deadline, you may be hit with not only another tax bill but also with a 10 percent early extraction penalty in case you’re younger than 59 ½.
However, if you still want to borrow a loan to tackle outstanding debt, here are some important points that you must consider.
• What type of debt is it?
The only type of debt you may consider to raid your funds to pay down is exorbitantly high debts like credit card debts or payday loans. It means, you should avoid raiding your nest egg for paying back loans with lower interest rates and long time span like mortgage debt and student loan debt.
• Do you have any other option?
You should consider taking out a loan from 401 (k) plan as the last resort. You must consider its alternatives, if any. For instance, if your credit score is good enough to borrow a loan from banks or credit unions to pay down high-interest credit card debt, you should do that instead of borrowing from 401 (k).
Or if you’re confident to manage your debt in the coming year, you can take advantage of a 0% balance transfer scheme to transfer your existing credit card debt to a different credit card and pay it back without any extra interest payment.
• Do you have any other plan?
You must not make it a habit to taking out loans. If your spending nature forced you raiding your retirement savings, then be cautious. And make a budget so that you don’t overspend.
Instead of raiding your savings, you should continue contributing to 401 (k) plan up to your employer match.