Dear Dr. Don,
My husband is 47 and is approaching his 30th anniversary with his company. He has $665,000 in retirement funds, with approximately $100,000-plus in 401(k) money and the remainder in a company stock and profit-sharing plan.
He is 100 percent vested and is weaning himself down from a "rapid growth" investment outlook to something more conservative. Here is our scenario and my question.
Our total debt, including first and second mortgages and credit cards, is $450,000. Our home is appraised at the same value. We have excellent credit and are paying 4.75 percent, 5 percent and 3.9 percent, respectively, on debt.
We haven't restructured our debt, as inevitably that would take us to 100 percent loan-to-value on the home, increase the interest rate and possibly force us to pay private mortgage insurance.
Would it be wise to borrow from my husband's retirement account to pay down the credit card debt, or perhaps the second mortgage? The payments are strapping us. We have four young children and are currently unable to save for their college.
My husband says that we will pay a penalty for this, and are limited in how much we can borrow and that we also have to start making payments on that anyway. (And I believe he said it would be 8 percent.)
I know it is generally not a good idea to borrow from any retirement accounts, but we are down to bare bones on the budget. In lieu of selling, what would you suggest? Is he receiving accurate info?
-- Money Mom
Dear Money Mom,
It's hard to see how you're going to free up money in your monthly budget by paying off credit card debts at relatively low interest rates with a 401(k) plan loan that will charge you a higher rate.
It's common for plan loans to have a five-year repayment schedule and for the interest rate to be at a slight premium to the prime interest rate, which is currently at 5 percent. It would be a bit unusual to have the plan loan rate at prime plus 3 percent, so your husband should check the loan rate on the plan loan.
A more common rate is prime plus 1 percent or 2 percent, for a total of 6 percent or 7 percent at today's interest rates. However, you've stated that all your loans currently have a lower rate than 6 percent.
Plan loans typically are limited to half the balance of the account, or $50,000 minus any outstanding loan balance in the past 12 months, whichever is less.
The biggest drawback of the plan loan is that you're paying back the loan with after-tax dollars that will be taxed again when you take distributions out of the account. The Profit Sharing/401k Council of America provides a complete listing of the pros and cons on its Web site.
Dialing back on current contributions to the 401(k) plan can free up money in your monthly budget. Of course, when you don't contribute up to the limits of the company's matching program, you're leaving money on the table.
I can't tell how much flexibility you have in your monthly budget, but I'd suggest paying down the credit card debt and living within your income instead of getting a retirement plan loan to restructure this debt.
I'd put your retirement ahead of the children's college funds in large part because it's easier to tap retirement funds for college costs than it is to tap college funds for retirement expenses.