Should I use an early IRA distribution to pay off my credit card balance?
Does it make sense to withdraw approximately $10,000 from my IRA and suffer the 10% tax hit on the amount in order to pay off $10,000 of credit card debt that's subject to 16% APR?
Great question. Generally withdrawing early is frowned upon in financial circles- often because it is unwise for the client, sometimes because the manager is worried about assets under management. The underlying question is can I pay the taxman more right now so that I can pay the Bank less.
Let's look deeper at the numbers to determine what is right* for you (*this is hypothetical given I don't have all your financial information and is done in rough numbers for education purposes only).
If you withdraw $10,000 you will only take home roughly $7,500 after 15% tax and 10% penalty assuming you make ~$45,000 a year or less. If you need the full $10,000 and have it available in your IRA, then we would need to take $13,350 to get the $10,000 you need to payoff the card balances. Total cost = $3,350 taxes.
(Again, if you are making $97,000 or less that could be closer to $15,000 withdrawal with a $5,000 cost)
Pay $500 a month over the next 2 years to pay off the cards. Total cost = $1,709 interest
(However, if it takes you more than 3.8 years to pay off the loans then your total interest cost increases to $3,400!)
In summary, the rough numbers seem to suggest that you'd be better off cutting money out of some other part of your budget to set up an accelerated payment plan rather than take the withdrawal.
A question like that is always more complicated and requires more context. Obviously you are under 59 1/2 if you are considering this. I would say, no, don't do it. Work hard and pay off the credit card some other way. The further away from 59 1/2 you are, the more strong my recommendatin is in this regard. Here's why:
1. If you take money out of an IRA (assuming it's not a Roth), you will pay current income taxes on the amount and a 10% tax penalty. This means that the cost of liquidating this will be a lot, even in year one. But the real concern, is that you lose the tax deferred growth of retirement money that this account was intended to provide for you. If you assume that your money might double every (7-8 years in this account - I'll show 7 for dramatic effect...lol), it would cost you something like this:
20k after 7 years, 40k after 14 years, 80k after 21 years, 160k after 28 years, 320k after 35 years (and so on...)
So the cost to you is much more than just the up front costs, but rather it is the opportunity costs. It's also a reason in places like Australia, they can't withdraw their retirement funds for purposes like these because they are designed for retirement.
I totally understand that the weight of the debt you are describing feels horrible, but there are ways you can get it paid off fast and not have to sacrifice your retirement.
Hope that helps.
No, it does not make sense. In addition to being hit with the 10% penalty, you'll increase your adjusted gross income by $10,000, and this has the potential of triggering other unintended tax consequences such as phaseouts of credits or reducing your itemized deductions. By withdrawing the $10,000 you will miss out on the growth of the market that we are experiencing right now. Depending on your age, that $10,000 could possibly grow to tens of thousands of dollars before you retire.
A better solution would be to implement a "debt snowball" or "debt acceleration" program to knock down the debt sooner than later. You'll save interest and pay off the debt sooner compared to making the minimum payments. The debt acceleration program will require you to pledge additional dollars on top of the minimum monthly payment, e.g. $50, $75, or $100, that you send in each month. You'll also need to stop using the card because you'd be defeating the purpose of the program if you keep spending using the card. You can find example spreadsheets on the internet to help you set up the plan. You do not need to pay for such a program.
Depending on your credit, you may be able to find a credit card with a 0% APR for balance transfers. If this is the case, you may find an offer that has no interest for the first year of the transfer. In your case, a 0% year would save you $1600 in interest. Now, isn't that better than paying $1000 in a penalty, and increasing your income? Good luck.
Most likely, no. Remember, the 10% tax penalty is just that,; a penalty tax over and above the income tax that you will pay on the entire withdrawal amount at your top tax-bracket rate. I would suggest a loan consolidation or, if you have a cash-value life policy, surrender any paid-up additions. They would be tax free. - Lawrence.Sorace@MulberryLaneAdvisors.com