Should my wife and I pay off our debt with our 401(k) or focus on building up the 401(k)?
We recently tried a business venture that did not work out. It left us with about $30,000 in credit card debit, a 9 percent personal loan for about $20,000 and no equity our house. We also have a 4 percent $250,000 mortgage and we also have about $100,000 at 5 percent school loans for my wife and kids. My wife and I both work and between us we can make the payments for everything but only paying the minimum. We are both 60 years old and we have about $110,000 in 401(k) savings. Should we use our 401(k) to pay off our debt and then focus on building up the 401(k)?
I encourage you to preserve and protect the 401(k) funds. This is critical as you are more near to retirement than you have ever been. Stick to the original purpose for the retirement funds and keep them in place. Do not let strangers (credit card companies and faceless lenders) derail what you have been able to save. Also, any liquidations would be taxable, so you do not get to actually use all that seems to be there.
Let's tackle the debt. Resolve that, for the next year or two, you will live on an austerity budget and buy only the barest necessities. I suspect the credit card interest is the highest and that needs to be paid off first. You might transfer the balance(s) to promotional offers that provide 0% interest for 12-15 months. Know that if there is likely a transfer fee, that will essentially amount to interest but is usually only 3-4%. It is possible to find some with no transfer fee. Then aggressively pay off the principal of the $30,000 debt so it is clearly eliminated before the promotional offer ends. The personal loan is the next priority. Explore ways to refinance at a lower rate. Perhaps you can join a credit union that offers loans to members at less than the 9% you are currently paying. In any event, the money you are not spending by being on austerity goes to paying this down.
The 4% mortgage is acceptable and you need a place to live, so I would not consider this a problem. If there was equity in the home, I might suggest cashing it out and renting for a few years, but that is not the case. The kids need to each take their own student loan responsibilities and everyone pull together here. Not sure how much that leaves for your wife's loan, but it should be less than the full $100k.
As a final consideration, you might want to borrow from the 401(k) to pay off some of the debt, but that will just create another payment for you. And the removal of funds from the 401(k) will inhibit its ability to grow as it otherwise would. There is also significant risk associated with the possibility that your employment may end and the full loan will become due or be considered a taxable withdrawal.
Hope this helps and I wish you the best.
I'm sorry the business venture didn't work out and you are left with this debt. I encourage you to try everything else before using your 401(k) money for the debt. In fact, if you can, I would add to the 401(k) as much as possible while you are paying down the debt (especially once the high-interest credit card debt is gone). My reasons are below.
ONLY HALF THE NON-MORTGAGE DEBT WOULD BE PAID OFF
Unless the money is in a ROTH 401(K), if you were to remove the money from the 401(k) you would owe taxes on the amount, and likely at a very high tax rate. (You would be adding $110,000 to your taxable income this year.) This means you will be left with maybe $75,000 to pay off debt, which is only about half of the non-mortgage debt you're dealing with.
RETIREMENT NEEDS TO BE JOB 1
Considering how close you are to retirement; your main goal right now should be to maximize your 401(k) accounts. Unless you have a strong pension, you will want a larger 401(k) savings to supplement your Social Security in retirement. Unfortunately, you are limited with how much you can put into your 401(k) each year, while you are not limited in how much of your income can go toward debt payoff.
401(K) MONEY IS PROTECTED FROM BANKRUPTCY
Based on your description, you are currently handling the debt ok; but if another financial problem, such as a job loss, were to occur, you might need to consider bankruptcy. The money in your 401(k) is protected from creditors and from bankruptcy. And your home is also effectively psuedo-protected from bankruptcy due to there being no equity. If you did have to declare bankruptcy having a home and $100k in your 401(k) could go a long way to helping you to rebuild your lives.
SUGGESTED NEXT STEPS:
Start by reviewing your budget and cutting everything you feel comfortable cutting. You may also want to consider talking to your children about them paying back their own student loans. While this might not be your ideal, realize you will be helping them more by making sure mom and dad are taken care of in retirement.
Take any extra cashflow and contribute enough to get each of your employer matches in your 401(k)s. Then put the rest toward paying off your credit card debt and then the personal loan. Once that is complete, you should consider paying the minimum payments on the school loans and the mortgage and putting the rest toward your 401(k) and other savings. This article can help explain the math behind contributing to the 401(k) instead of paying off the student loan debt and mortgage.
You might consider a taking 401(k) loan, but not a withdrawal, to pay off your high-interest credit card debt. Do this if and only if you're committed to paying your credit card balances off in full before the end of every statement cycle. Save as much money as possible and pay off your 401(k) loan before you retire.
There are several options. Without knowing monthly payments on each, it is impossible to do a side by side comparison. But here is my initial thought. Pay off the $20,000 personal loan with the 401k. Use the payment amount from the paid off loan and add all of it to your monthly payment on your credit card debt. When the credit cards are paid off, use the former credit card payment and the former personal loan payment to add to the current school loan payment. Pay the minimum on your mortgage. Realistically you will not get this paid off, and partial principal payments don't help with your cash flow. The goal is simply to create the most net cash flow. Ideally, you will be debt free other than the mortgage and your 401k will have grown back to its original $110,000 or more to generate some added income.
At age 65 I would revisit the mortgage. You didn't mention the value of your home. But I would look at whether a reverse mortgage by its self or in combination with all or part of your 401k would pay off your mortgage. You could then be debt free. But do you have enough income without the 401k, would be the question.