Should I withdraw from one of my retirement accounts to pay off debt before they potentially decrease in value?
I am in $50,000 of credit card debt. The monthly payments are killing me. I have a 401(k) with $120,000 from my previous employer, a 401(k) of $17,000 with my current employer, and a Roth IRA of $40,000 with Vanguard. That is all I have for emergencies. But, if times get rough through this current administration, won't my retirement accounts take a dip as well? Should I pay my debt off now that my retirement accounts are doing, what I think is, good? If I do withdraw from my retirement accounts, where should I take from first?
You are in a difficult situation, and I can understand because many people have taken on way too much debt. As an advisor, we can recommend what types of accounts, and how they are taxed. Given I don't have much information other than the debt and the accounts, it makes answering your question more difficult. What is your current age? Your 401(k)s and IRAs have 10% early withdrawal penalties.
I'm sure these monthly payments are killing you, but if I were you, I would explore these options first:
1. Some type of debt consolidation loan. If you currently own a home, a possible choice would be to refinance your existing mortgage for a better rate, and take existing equity out to pay down debt. Mortgage interest may be used for tax advantages, but please consult a tax professional.
2. Talk with your credit card companies. This can sometimes help with reducing interest rates to help pay them off.
3. Talk with your current employer about taking a loan against your existing 401(k) which can have lower rates and I would also think about moving your old 401(k) into your current 401(k). Your new 401(k) provider should be able to assist with this.
4. Your Roth IRA has already been taxed, but will still be assessed a 10% early withdrawal penalty and additional penalties. (To make qualified distributions from a Roth IRA, you must be at least 59½ and it must be at least five years since you first began contributing. And if you converted a regular IRA to a Roth IRA, you can't take out the money penalty-free until at least five years after the conversion.)
So, before you do anything, consult a tax professional on this matter.
I agree with the other answers. You should definitely not take money from a retirement account. I have only one thing to add.
You didn't get into a $50,000 hole all at once. I'll presume that you had a period of un- or under-employment and it was necessary to borrow (If you didn't, then you have a real spending problem and need to impose strict austerity measures right away). Start immediately on a program of cutting out nonessentials from your monthly spending. Cook at home. Don't buy clothes. Travel cheaply, if at all. I don't know your take-home salary or your essential budget, but devote every other dollar to paying down debt. Every dollar. The stricter you are with yourself, the shorter the time you will need to do it. I know I sound like an awful tyrant, but I speak from experience. You can do it. Best of luck.
Two points that I would add to the previous answers:
1) It is possible that you can withdraw at least some money from your Roth IRA without penalty, depending on what portion of the account represents contributions (as opposed to investment earnings). In a Roth, the "contribution portion" and the "earnings portion" are treated differently for tax purposes. Contributions can essentially be removed at any time without penalty, since you've already been taxed on the money in question. The earnings portion, however (any capital gains or interest earned on those contributions), will essentially have to remain in the account until retirement, unless certain exceptions are met. Otherwise, taxes and penalties will apply. It's still not necessarily advisable to do so, since you'll lose the benefit of years (or decades) of tax-free investment growth, but it is at least possible to do so without incurring a penalty.
2) Don't fall into the trap of thinking that the "current market environment" (or your read on it) is relevant to this decision. There is essentially no market environment in which you have a reasonable expectation that your investment return will equal (or outstrip) the rate that you owe on your credit card balance. Credit card rates tend to vary between 9% and 19%, while the average pre-tax return for U.S. stocks hovers around 10% (with substantial volatility, of course). Therefore, at best, you can hope to tread water by continuing to hold credit card debt. That's true whether you think we're in a bull market, bear market, sideways market, or facing an imminent crash. Retiring high-interest debt should always be a priority. I certainly wouldn't want you to pay huge tax penalties in order to retire that debt, but I wouldn't get so cute as to think that market-timing is a major factor here. It's a minor factor. The rate on your credit card is the only relevant factor, and it's likely to be much higher than any reasonable investment return expectation.
I’m sorry to hear that your debt has become too much to handle. The worst place to take funds to pay off debt is from tax deferred accounts like a 401(k) and IRA. This is especially the case if you are under 50 years old due to the penalties involved. I’ve included a link to an article I wrote that goes into more detail called Tax-deferred vs. Tax-free Retirement Accounts.
Rather than looking to your retirement accounts, you may want to consider some sort of credit counseling plan or talk with an attorney about the best way to preserve your assets. If you had to take from a retirement account, the Roth IRA would be the least painful from a tax standpoint.
I hope you find this helpful. Best of luck.
Please note that this should not be considered investment advice and is only educational in nature. Be sure to consult your own investment, tax, or legal professional for help with your specific situation.
Best of luck!
David N. Waldrop, CFP®
Ideally, you need a detailed analysis of cash flow, taxes, and other risks, but generally speaking, please consider the following before you pay the taxes and penalty:
- A cheaper consolidation loan, if possible
- Taking out your Roth contributions, contributions are available tax and penalty free. TAKE FROM THIS ACCOUNT FIRST
- A 401(k) loan
- A loan on life insurance or a return of basis on a life insurance product
I know it is tough to deal with that kind of debt, but please explore all your options.
Mark Struthers CFA, CFP®