 Dear
Debt Adviser,
If the economy crashes, I know my 401(k)
will disappear, but my debt won't. So, I was thinking of raiding my 401(k)
to pay off my credit card debt. What do you think?
-- Stephen
 Dear
Stephen,
This is curious thinking. Do you think that if you
go on a crash diet you will disappear? Chances are you may just shrink before
regaining your former stature. People have many reasons for "raiding"
their 401(k)s, but banking on the economy crashing is a new one to
me. I believe I understand your concern. You think that your 401(k)
will be worth much less if the economy takes a turn for the worse. In this, at
least, we can agree.
I enjoy traveling abroad. When I see
a purchase that I am on the fence about, I often say to my wife, let's buy it
before the dollar is completely worthless! However, this is very different from
using retirement funds to pay off a credit card, so let's go on. I
am willing to go out on a limb and state that you will at some point want to retire.
It is generally considered desirable to have an income source other than Social
Security in order to accomplish that goal. If you raid your 401(k)
now to take care of your credit card debt, you may be putting your retirement
in jeopardy. Reason being, the money that you "raid" will be taxed at
your current income tax level, rather than the likely lower level that you would
be at when you retire. You will also be hit with a substantial early withdrawal
penalty. As a ballpark estimate, figure you will lose as much as 50 percent of
the value of your savings. However, the biggest hit that you
take by withdrawing from your 401(k) is future earning potential.
Even crashes recover. I had the unpleasant experience of riding the market down
between 2000 and 2003. Since then I have been pleased with the return enjoyed
by my 401(k) and it is now larger than ever. Nothing
in your note refers to stopping your spending or increasing your savings rate
once your debt-du-jour is paid down. Unless you replace the funds, you lose the
earnings on the balance that is not replaced. Depending on the amount, it could
be significant. My recommendation is that you leave your 401(k)
intact, continue to make regular contributions, if you can afford it, and explore
other options for paying off your credit card debt.
 |
Paying off your debt | |
|
| • | Stop
the charging now! Resolve to buy only those things that you can pay for with cash
on hand. | | • | Hold
on to your current vehicle for longer than you may have planned and use the car
payment you won't have to pay down the debt. | | • | Eat
out less. For many Americans, this is a shockingly high expense. Brown bagging
your lunch and limiting your other restaurant ventures may wring more money than
you expect from your budget. Put those savings to work on your credit card debt. |
| • | Sell
something. Hold a garage sale or raid the attic for items that you no longer want
and sell them, maybe online. | | • | Use
"found" money to pay down your debt. This is money from income tax or other refunds,
pay raises or bonuses, even money saved by cutting coupons. | |
I hope an economic crash is not in our future, but either
way, keeping your savings, even in very conservative investments like a money
market fund, while paying off your credit card debt is the way to go. A friend
of mine recently reminded me that you will always have Paul's support if you rob
Peter. Well, that doesn't go for Steve! Good luck! |
