 Raiding
401(k) to repay credit card debt
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 Dear
Steve,
My husband and I have about $40,000 in credit
card debt, and I know that in October the minimum payments will
double. I'm considering borrowing from my retirement savings to
pay off some of this debt. Do you think this is wise?
-- Robin
 Dear
Robin,
That's a lot of credit card debt you've got there.
And you are right about those minimums increasing soon. Under new
federal
guidelines, almost everyone who is carrying a credit card balance
can expect higher minimum payments before the end of the year. But
I am not so sure that you should borrow from your retirement to
decrease your debt.
You didn't say what type of retirement account you
have, but I assume it is a 401(k), since these plans
often have a provision for borrowing up to 50 percent of the vested
value. Repayment is generally through payroll deduction, and interest
is usually charged at a low rate, which is credited to your account.
Repayment begins immediately and in most cases must be paid off
in 60 equal monthly payments over five years. There is no penalty
for prepayment. Sounds good so far, right?
Unfortunately, there is this guy out there whose name
is Murphy. He is so popular that he has a law named after him. Murphy's
law says: If something can go wrong, it will. So let's look at what
can happen.
If you lose or leave your job before the loan is paid
off, the balance of the loan usually must be paid in full at termination
or it will be treated as a distribution. "Distributed"
401(k) money triggers a federal tax penalty, of 10
percent, for early withdrawal if you are less than age 59½,
and you will have to pay federal income taxes on the distributed
amount. If you are in a 25-percent tax bracket, the taxes plus penalty
mean you will have to surrender 35 percent of your balance. If you
live in a state with an income tax that will be charged, too, you
could lose as much as 50 percent to state and federal income taxes.
Check your plan for specifics before you do anything like this.
The reason this penalty exists is because Uncle Sam doesn't want
you to use your retirement to pay off your debts; he wants you to
save it for your retirement! So do I.
Even if you feel your job is as secure as Fort Knox
and you will not have a problem with the additional withdrawal from
your paycheck, I would urge you to try another method of getting
your debt down before breaking open the retirement piggy bank.
Here are my suggestions:
- Stop using the cards. Don't add more to your pile
of debts; use cash.
- Set some goals. Agree on some five-year goals for
you and your family. Make one of them to retire the debt in 60
payments or less. Few people can live like monks for five years,
though, so make sure your plan includes some fun and affordable
goals. They will give you incentives to stick to your goals.
- Get a plan. Develop a spending
plan that encompasses your goals and current needs. Make it
real by posting pictures of your goals and dreams on the refrigerator
so you both can see them every day.
My bottom-line advice is to not rob tomorrow to pay
for yesterday. If you don't stop, when you get to tomorrow, you
will find that it has been emptied not only of money, but of hopes
and dreams as well.
If you can't agree on the goal-setting and spending
plan, find yourself a good, accredited credit counselor to help
you find a way out of this $40,000 debt without risking your future
to do it. Good luck!
The Debt Adviser, Steve Bucci,
is the president of Money Management International Financial Education
Foundation and the author of Credit
Repair Kit for Dummies. Visit MMI
for additional debt
advice or click
here to ask a debt question.
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