Paying off Credit Card Debt
From FinancialPlanning
Contents |
Things To Consider before Tapping Into Your IRA or 401(k)
You'll Pay Taxes & Penalties
Unless you have reached retirement age (generally, 59 1/2 or older), tapping into retirement accounts to pay off credit card debt can be a costly move. These "premature distributions" trigger both income taxes and penalties. For example, if you withdraw $5,000 from an IRA you're subject to a 10% penalty ($500) on your federal income tax return for taking an early distribution. Your state may also assess a penalty; in California it's 2.5% (another $125). Then you pay income taxes on the $5,000 distribution, which may be another 35% or more ($1750), factoring in both federal and state income taxes. Altogether, you may end up with little more than 50 cents of every dollar withdrawn, after paying interest and penalties.
You'll Have Trouble Replacing the Money
Your annual contributions to retirement accounts are limited by law, so you may have a hard time replacing money that you withdraw, even if your intention is to do so once your finances turn around. For example the current (2007) limit on IRA contributions is $4,000 per year. Take out $12,000 and it will take 3 years of contributions to replace it.
Is it Masking the Real Problem?
If you're tapping into retirement savings to pay your bills, something's off...either you're saving too much, or spending too much (usually the latter). Running through your savings may just delay some changes that you need to make in your spending habits. It may be better to make those changes before tapping into your retirement savings.
Does It Ever Make Sense?
If the interest rate on your credit card(s) is very high, and you're confident that you won't just run up the balance again once you pay it off, it can make sense to tap into retirement dollars for this purpose. But the consensus on MIFP is that this is a last-ditch source of funds, one that you consider only after exhausting all alternatives.
