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Dear Penny: When Does It Make Sense To Use A 401 (k) To Pay Off Debt?

Dear Penny: When does it make sense to use a 401 (k) to pay off debt?


Dear Penny,

I’m 59 years old, divorced, and have about $ 20,000 in student loans and $ 8,000 in credit card debt. My only savings is a very small 401 (k) with $ 17,000 from a job I lost about a year ago.

I’m starting a job with a large, reputable company in a couple of weeks. I rent a little house month after month and have a car big enough to live in when I need it.

Now should I take my 401 (k) money and repay my credit card debt and as much of my student loan as possible? I was told that in this case I would lose 24% tax.

-K.

Dear K.,

It’s so tempting to take a bite of the 401 (k) apple when you’re in debt. And your 401 (k) funds are likely to look particularly attractive as you are or near the magical age of 59½ where you can access these funds with the IRS without incurring a 10% penalty numbers.

I urge you not to spend your 401 (k) on paying back your debt, but the tax implications you mentioned are not my primary concern.

Your 401 (k) is an asset that, with a few exceptions, is almost always protected from creditors, e.g. B. if you pay child benefit or taxes. The same goes for IRAs and pensions.

That said, if you can’t pay off your debt and your student loan service provider or credit card company gets a court ruling against you, they won’t be able to affect your $ 17,000 retirement plan. Your retirement accounts are also usually protected when you file for bankruptcy.

That $ 17,000 could be a lifeline in a crisis – for example, if you have a medical emergency or lose your job before you are eligible for Social Security.

OK, now let’s talk about taxes: your 401 (k) withdrawals will be taxed on what the IRS calls “normal income”. In other words, it’s taxed like a paycheck. How much would you pay in taxes if you added $ 17,000 to your paycheck for the year? Let’s say, as a single applicant, you need taxable income of between $ 84,201 and $ 160,725 in 2019 before being taxed at the 24% tax rate you mentioned, without having to dig into how tax brackets work.

Aside from the specifics, let’s just assume that your income will be higher when you return to work than when you retire. If you withhold 401 (k) withdrawals until you are no longer making a paycheck, you will likely pay less tax.

However, your focus should be on getting rid of the $ 28,000 debt, especially since your retirement years are approaching.

The good news is that you are starting a new chapter. You are about to start a new job so you can better off your debt so that you can be debt free in retirement – and in the meantime, can afford your rent.

They are not telling you whether the income from your new job will be enough to meet your basic needs and pay off your debts. If you have any extra cash left over after bills and minimum payments, start using whatever you can to pay off your credit cards, which are likely to have higher interest rates than your student loans.

Regardless of how much your new job pays off, you should also look for ways to make money on the side so you can get your debt under control quickly and replenish your retirement savings. Even if you’re making an additional $ 200 or $ 300 a month from pet care, grocery delivery, or driving for a hail service, you can still pay off your debt significantly faster.

If you resist the temptation to get money out of your 401 (k) now, you’ll sleep better knowing you have saved money that no believer can touch.

Robin Hartill is the Senior Editor at The Penny Hoarder and the voice behind Dear Penny. Write Dear Penny and your question may be answered in one of the next columns.


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