The Benefits and Penalties to Using an IRA to Pay Off Debt
Last week, we received a question from someone wanting to know whether it was a good idea or not to withdraw 401(k) plan money to pay debt off. Questions like these are always best taken on an individual case basis. Let’s see what the situation is.
My husband has been contributing the maximum match with his employer 401k. He took out a majority of it, $34,000, last year and transferred to a Traditional IRA. He used a CD of 7 months for the IRA because he was considering taking out $20,000 in July and pay his truck off and then using a Roth IRA for rolling the rest of the balance into. He plans on continuing to contribute to the 401k for another year when he will retire. At this point that is our plan. What is your advice?
First of all, maximizing contributions in order to meet his company’s 401k match is the right thing for your husband to be doing. Taking advantage of any free money is always good. That is what a company match is. However, you shouldn’t ever interchange retirement accounts with savings accounts. You also should n’t use them for meeting short term goals. A retirement account works the best when you use it for just one thing- retirement.
There are some great tax deferral benefits given by the government for Traditional IRAs and 401k plans. Roth IRAs have a different investment benefit, but it is just as valuable over the long term. In exchange for these benefits, there are strict penalties on early retirement account withdrawals. First there is a 10% penalty and then you are also taxed on earnings if the 59 ½ age requirement isn’t met.
The information you provided was limited. If penalties won’t apply because minimum age limits have been met for withdrawing money, then early withdrawal penalties aren’t something you will need to worry about. However, there will still be taxes due upon withdrawal. Another concern I have is whether you have enough money or not set aside for retirement. I strongly advise you to carefully review you retirement plan to see whether you have sufficient resources for supporting your retirement.
Another things you need to consider is having an emergency fund if you don’t already have one. If not you might want to think about keeping that $34,000 as an emergency fund or the $14,000 remaining. An online savings account is a great place for keeping the fund because it has decent interest rates but is still liquid.
Withdrawing money out of tax advantaged accounts comes with serious penalties. Unless you have serious financial difficulties such as a bankruptcy that is imminent, I don’t think withdrawing IRA money is a good idea.
Do you have enough money for retirement? If money is withdrawn for paying off the truck, that leaves you with about $15,000 plus social security. Maybe I missed something. The amount of income that can be generated from $15,000 over the long term is around $50 per month. Have you gone to the Social Security website to have an estimate done on what you would probably qualify for?
Thank you for contacting us. I wish your husband and you all the very best with your retirement plans.
