Should You Pay Off Credit Card Debt With Your 401K?

By | August 31, 2021

Although the answer is almost always “no”, there are exceptions.

It is a good idea to use money from your 401(k), to pay off high-interest credit cards debt. Although financial experts almost always say no to this question, they will admit that there are times when your retirement fund may be able to help you pay off high-interest credit card debt. Let’s take a look at the process.

Avoid Withdrawals from Your 401(k), Unless You’re Over 60 Years Old

Avoid straight withdrawals from your retirement plan (401(k),) as they can lead to severe penalties. This amount will be subject to income tax and a 10% penalty. After all deductions, a $10,000 withdrawal could result in a $6,000 loss. This is a terrible deal.

This exception would only apply if you withdraw after 59.5 years. The 10% penalty is no longer applicable. If you are working less, your withdrawal will be subject to a lower tax rate of 10%. This could make it more appealing, but not ideal. Withdrawals are now mandatory at 72.

You can temporarily withhold 401k payments

You can withhold your contributions from your 401(k) until you have paid off your high-interest debts. It’s easy to reduce contributions indefinitely and this can irreparably harm your retirement savings.

Before you withdraw from your 401(k), if you are unable to repay credit card debt, you should first discuss a hardship program with the lender.

If your 401(k), which includes employee matching, you should continue making contributions that amount to whatever percentage they are willing to match. If you don’t have to, you shouldn’t miss out on what is essentially free money.

You can also take out a loan from your 401(k).

According to Investopedia, you can borrow up to 50% of the vested balance or $50,000, whichever is lower. A 401(k), unlike personal loans, won’t be denied. The interest rates are usually lower (typically below 5%), and there is no need to have a hard credit check. This can temporarily affect your credit score.

You have to repay the loan and interest within five years. You’ll also have less time to repay the loan if you get fired or quit. If you default on repaying the loan, it will be treated as a withdrawal and you’ll pay all the taxes and penalties. (For more information, see this Lifehacker post).

As you can see there is a lot at stake when making such a move. You should first explore all options for debt reduction, such as hardship relief programs and a debt management program. This Lifehacker article will provide more information about your options.

Bottom line

There are situations in which your 401(k), if you can’t pay your credit card debts, can be used to repay them. This is not a good idea and it’s not something you should do. Before you raid your 401(k), consult a financial advisor. They can help you assess your financial situation and determine the next steps to pay down your debt.

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