When you have a large amount of high interest debt, it may be tempting to access the funds in your 401k account to pay it off. The temptation to free yourself from the burden of reoccurring payments, and save yourself thousands of dollars in interest can be great, and a large debt burden can jeopardize your ability to obtain financing for other things such as a car or a home.
Before you rush out and use your 401k to pay off debt there are some important considerations to take into account including your age, available capital and time frame for investing. You must also remember to look at all of your options for securing capital including unsecured loans, consolidation loans and 401k loans to pay off high interest debt.
While it is not advised to take on more debt to cure your debt problem, in certain circumstances, low interest loans and consolidation loans can help you reduce debt faster – and therefore cheaper – and in the case of 401k loans, may not be reported to the credit bureaus and will not negatively affect your credit rating.
Always consult with a financial expert before withdrawing any funds from your retirement account. The trained investment experts at ETrade are available to assist you with all of your investment and debt questions, and can formulate a plan tailored to your specific needs.
Options For You To Use Your 401k To Pay Off Debt
If you have no other option but to use your 401k to pay off debt, you should first consult with your plan administrator concerning the possibility of obtaining a loan against the funds in your 401k rather than withdrawing the money completely from your account.
By utilizing the loan option, you can avoid the IRS fees and taxes that are imposed on withdrawals from 401k accounts prior to the owner turning 59½ years old. The interest rate on 401k loans is usually proportionate with the amount earned in interest while the funds were tied to the account.
Access your Summary Plan Description to learn about the terms under which early withdrawals are permitted. Typically, you must be in severe financial distress in order to be able to take early distributions from your retirement account with no penalties.
Only withdrawal as much as you need to pay off your debt, and use the funds for their intended purpose promptly. If your are less than 59½ years old, do not forget to plan for a reduction to your available funds due to income taxes and early withdrawal fees. You could avoid these fees by withdrawing your funds in yearly installments, although that would defeat the purpose of eliminating monthly debt.
Develop A Plan To Return The Money To Your Account
The main risk you run when your use your 401k to pay off debt, is that you have not really solved the problem that got you into high debt in the first place – excess spending. You must establish and stick to both a plan for repaying the funds withdrawn from your 401k account, as well as a workable budget to help you live within your means.
The Home Budget Calculator at online broker ETrade can help you formulate a spending and investment budget that works best for you. You can prevent long-term damage to your financial future by learning to budget and save your money, and replacing the funds withdrawn from your account.