Would you borrow from 401k to pay off debt?

sweetsunnyc · September 2014

Maybe borrow isn't the right term, but I am looking for advice/suggestions. H and I have both changed jobs within the last year, so the 401k's that we have from previous employers are just sitting there. I plan on rolling mine over to my new employer as they start to contribute after a year of employment. H has gone the way of more self employed/contract work, so we were considering putting his into a Roth IRA. Here's my question- We have about 7k in credit card and medical debt that I would like to pay off in full. Would it make sense to use a chunk of H's funds to pay off debt before we put it in to a Roth? Main reason is that we want to improve our credit- we don't have a ton of CC debt per say, but the fact that our balances are almost maxed kill our scores. Also, just getting rid of these small payments would save us over 400 per month. The financial guy that we are working with (he's with State Farm, so legit) talked like this is something that people do all the time, so no biggie. My parents are like- no way. Never take from your retirement. I'm not sure what to do and wanted to get some input. I will be the first to admit that both H and I are not financial wizards, so I am looking for honest feedback.

CarrieB. · September 2014

Generally, you cannot take a loan from a 401k if you are not an active employee.

Your insurance guy just wants you to buy more insurance. He's not an expert in retirement planning.

Pips09 · September 2014

I am of the thought that you never touch your retirement funds (except for dire emergencies, maybe). It is way too easy to use that money for other things once you think it's available to you when you need it. You will pay a hefty tax penalty for taking that money out, too. I'm not a financial advisor, so I don't know the best solution for you, but no, I would not do that.

sweetsunnyc · September 2014

CarrieB. said:

Generally, you cannot take a loan from a 401k if you are not an active employee. Your insurance guy just wants you to buy more insurance. He's not an expert in retirement planning.

This is right, so it would be cashing it out, using some of the money to pay off debt and putting the rest in to an IRA. I should have stated it better in my OP

[Deleted User] · September 2014

The State Farm guy is not a financial planner. I would talk to an actual financial planner.

CarrieB. · September 2014

sweetsunnyc said:

CarrieB. said:

Generally, you cannot take a loan from a 401k if you are not an active employee.

Your insurance guy just wants you to buy more insurance. He's not an expert in retirement planning.

This is right, so it would be cashing it out, using some of the money to pay off debt and putting the rest in to an IRA. I should have stated it better in my OP

So if you take a distribution, you will be taxed and you will have to pay a penalty fee. Not worth it to me to pay off debt.

[Deleted User] · September 2014

I would be more willing to roll it into a 401k that has a loan option. You can take a loan on your 401k at a much lower rate than a credit card. You miss out what it would earn during the loan period but you aren't taking a distribution (so no taxes).

Those may be hard to find that aren't employer owned. But it is worth a look.

I would only consider cashing out after talking it through with an actual financial planner. I worked for SF back in the day. Chances are he is not a legit financial planner. I had very little training to sell financial products. And most of that training was software training.

mlee116 · September 2014

MarlaSinger& said:

The State Farm guy is not a financial planner. I would talk to an actual financial planner.

Ditto this. And check into the tax consequences like PPs said. We had clients who did this without checking into it first and were in for a huge surprise at tax time. Not only did they owe a lot more taxes than they planned, they couldn't pay all or part of them, so they had to pay interest/penalties on the tax.

IMO, I wouldn't do it unless it was a dire situation. And certainly not for medical debt as most hospitals/providers will allow you set up a payment plan. I'd rather do that and not lose 30% of the retirement fund to penalty taxes from the get go.

IrishTraveler · September 2014

The thing is you aren't "paying off the debt." You're moving it around. And if you borrow against a 401(k) and leave the job, it must be paid back within 60 days or you'll owe all of the penalties and interest. Aside from all of that, you're going to lose any growth you might have had by taking the money out. It really isn't a good plan.

sweetsunnyc · September 2014

Thanks for the input. I agree that my first step is speaking with an actual financial advisor. I think that I am looking at this from more of an emotional perspective rather than a financial perspective Like K3am mentioned above, it would be more of starting with a "clean slate"

[Deleted User] · September 2014

I would be more apt to come up with a plan to pay it off in x amount of time. If you have a checking account you don't use a lot, direct deposit a certain amount from each check into that account. Then that account can only be used to pay off debt.

Then set it up for automatic bill pay so you are less likely to transfer the money elsewhere and spend it.

I know you want to raise your credit score but is your credit low enough to effect what interest rate you get on auto and mortgage? Or is it more mental?

Mustardseed2007 · September 2014

In the situation you describe, no I would not. It sounds like you're doing it to reduce the amount of your monthly payment and improve your credit score. Rather than cashing out your funds which will have tax implications and make this a costly endeavor where you are really loosing more funds when cashing out than you would in paying interest, I would just continue paying your monthly payment and pay additional towards it as often as you can to shorten the amount of time you are paying interest.

lifeinthedreamhouse · September 2014

It wouldn't be worth the tax losses to me. There is a penalty plus your normal tax rate so you would lose about 40%. I didn't think you said how much you have in the 401k so you might not even have enough to pay off the debt after your taxes. I follow Dave Ramsey's financial plan and I would highly recommend that you check that out.

Before I found Dave Ramsey, I did cash out a 401k and I regret it. At 34 now, I feel really behind on my retirement savings.

groovygrl · September 2014

I'd agree that the penalties are not worth it & also chime in on the financial planner, ask around to people at similar income levels to you and see if anyone has someone they really like (I only say that b/c I'm pretty sure they all have different income brackets they work with or something along those lines).

Also on the rollover if the previous job had any other retirement benefits that he was eligible for, make sure you know if they're affected if you roll over... this is probably pretty rare anymore, but I actually qualified for retirement benefits like healthcare when I left my last job and therefore, if I roll over the 401k from there into my current one or a future one I have to forfeit those benefits. While I know that when I actually retire those benefits might look completely different than what they are for retirees right now, we decided not to risk it just to roll it into 1 fund. Just something to make sure doesn't affect you!

70point3 · September 2014

No. No. No.

Look into Dave Ramsey if you're looking to pay down debt. We did it years ago (pd of over $100k) with his methods.

kikimeemee · September 2014

Watch Suze Orman on CNBC - she's awesome!! (Saturday nights) She'd tell you no, no, no ... Don't take retirement money out to pay debt.

Oh, look -- I found a video for your very question and Suze says "no! No! No!"

https://www.suzeorman.com/resource-center/suze-orman-money-tips-video-collection/401-k-advice/

sandrabrooke · September 2014

Your just rearranging the debt and you get hit with penalties. I'm a CPA working in finance and I just can't see this being a good idea right now. It doesn't seem dire enough (extreme job loss, life or death stuff, etc)

kikimeemee · September 2014

70point3 said:
No. No. No.

Look into Dave Ramsey if you're looking to pay down debt. We did it years ago (pd of over $100k) with his methods.

Way to go!!!! More people should learn from you. Impressive. ::applause::

sweetsunnyc · September 2014

Quick update-

My employer offers EAP (employee assistance program) which allows us free access to a financial advisor, so I am going to schedule that and get some advice. It seems like it is a bad idea to cash it out, so we will be looking at other options. The main reason that I wanted to pay down debt quickly is because I want to take advantage of doing a streamline refi on my home as my ex and I owned it together and I would like to get his name off the loan. I don't have anything outstanding, but my credit score is a few points lower that what is required to do the streamline, due to the high balances on my card. My though was if I could pay these off, I could get the refi done in a few months. FWIW- I want to do this refi option as it is no cost out of my pocket and only takes a few weeks to complete. Thanks everyone for your advice.

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