Don’t use your 401k to Pay off Credit Card Debt

When it comes to 401(k)s, the general advice that most financial advisers give is that you should put in as much as you can afford and at the very least, if you employer matches a portion, save the full amount that will be matched. Since 401(k)s are contributed to before taxes are deducted, removing money from the account can come with penalties and, at the very least, the tax is due on your next income tax.

These days, many 401(k)s are not earning a lot of interest. Credit cards on the flip side, are charging very high rates of interest. It can be very tempting to use the savings that you have in your 401(k) to pay off your high interest credit card debt. Is this a good idea? The best answer to that question is maybe.

Not all employers offer the option of borrowing from your 401(k). If your employer does offer it, the federal government has set the limits on how much may be borrowed. They have determined that you may borrow 50% of the value that you have donated to the plan up to a maximum of $50,000.

You also need to remember that some employers put restrictions on the number of loans that you can have outstanding and they also determine the interest rate that will be paid.  In some cases it can be quite high. Some plans require that you get the consent of your spouse before you borrow from your plan.

There are a few things to consider when you are thinking about paying off your credit cards with your 401(k). You do not want to remove the money permanently. If you are over 55 years old, you can remove money from your 401(k) for any reason, whenever you want with no penalty. You will however, as stated above, have to pay income tax on the money you withdraw.

Before you decide to take a loan from your 401(k) consider the stability of your employment. If your employment was to terminate, you loan would be due and payable within 60 days. This could create an additional hardship beyond just losing your job. If you could not make that payment, then it would be considered a withdrawal and if you are younger than 55, there will be a 10% penalty in addition to the tax burden.

Before you borrow from your 401(k) it is best to determine where else you could find money to pay off your credit card debt. You also should be sure that you are not going to run up additional credit card debt now that you have paid off your balance. If you have not changed your spending habits, you may end up owing a loan and also owing more credit card debt. Getting a loan from your 401(k) can seem like a quick fix, and in reality it is.  For it to be a good idea, there has to be a change in the way that you use credit cards  or it will be a very bad decision.