Use Retirement To Pay Off Massive Credit Card Debt?

Added March 20, 2009 by Ilyce R. Glink

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Summary: Even if you’ve reached the age to withdraw from your 401(k) penalty-free, you’ll still have to pay taxes to take out a large chunk of it. If you’re considering using the funds from a 401(k) to pay off debts, think about using the equity in your home instead. Dipping into your 401(k) will cut into your retirement and could mean financial trouble during those golden years.

Q: I was downsized from my job three years ago and accumulated $40,000 in credit card debt. I am now 62 and have approximately $120,000 in a 401(k) account that I can access penalty-free.

Should I take the money from the 401(k) account to pay off my debts? I could then reinvest part of the money that I'm not using to pay off the credit card payments. The debts are really wrecking my quality of life.

A: If being in debt is wrecking your life, then take out the cash and pay off your debts. But to get $40,000 in cash, you'll need to take out around $60,000 in order to pay all the taxes that would be owed on this cash. That isn't really the smartest thing you could do. If you have a house with equity, you're better off doing a cash-out refinance and paying back the mortgage over time.

Or, you should consider getting a part-time job during the holiday season (retail stores are always looking for extra help this time of year) and dedicate the income toward paying down your debt.

Or perhaps combining the two strategies (taking a part-time job and withdrawing some funds from your 401(k)) might be the answer.

What I'm really worried about is your income going forward into retirement. If you can't find another job, or no longer have any interest in working, you'll wind up with just $60,000 in order to fund your retirement. At today's interest rates that'll put just $300 to $500 in your pocket each year, hardly enough to pay your heating bill.

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