If you need funds to pay off high-interest debt, it may be tempting to tap into your retirement savings.
However, it’s generally not a good idea to withdraw from your retirement savings until you’re 59 1/2 years old. Withdrawing from your retirement account before this age can trigger penalties, plus you’ll have to pay income taxes on the amount you withdraw.
Taking money from your retirement account early could mean you’ll have less to draw on once you reach retirement age, because you won’t just lose out on the amount you withdraw, but also any gains it would earn if it remained invested until you retire.
You may want to consider alternatives, such as a debt consolidation loan, a balance transfer credit card offer or a 401(k) loan. However, each of these options has its own pros and cons. The following could help you decide whether drawing on your retirement funds is the right choice for you.
Consider your situation
Take time to carefully think through your debt and your options. Ask yourself the following questions:
- What kind of debt do I have?
- How much debt do I need to pay off? By when?
- How much interest is accumulating on the debt? How quickly?
- Do I have any other options besides my retirement savings, such as an emergency savings account or other assets?
- Is the cost of paying penalties and income tax on the amount I want to withdraw from my retirement account more than the cost of paying down the debt plus interest through savings or a loan?
Think through the pros and cons
It’s essential to think through the short- and long-term benefits and tradeoffs of using your retirement savings to pay off debt.
Pros:
- You can access your retirement savings fairly quickly
- You won’t have to go through a credit check, application or approval from a lender
Cons:
- You’ll most likely need to pay income taxes on the withdrawal
- There will probably be a 10% penalty on the withdrawal if you’re under 59 1/2 years old
- You’ll have less for retirement later on
Alternative solutions
Before withdrawing from a retirement account, it’s generally best to consider other options first.
Revise your budget
Taking a hard look at your budget may be worthwhile if you think you can pull together enough to pay down your debt by cutting expenses.
See if you can eliminate any nice-to-have costs such as streaming subscriptions, eating out, gym memberships and so forth.
While it may seem like small savings here and there won’t make a big difference, you never know where you might find extra cash.
Look into a debt consolidation loan
A debt consolidation loan is a personal loan that rolls some or all of your debts into one new loan with a single monthly payment, ideally with a lower interest rate than what you’re currently paying.
Debt consolidation loans can be a good way to streamline your debt payments and optimally should reduce interest costs overall, giving your budget a little—or a lot—more breathing room.
Consider a 401(k) loan
If you have a 401(k) and your employer allows for it, you could borrow against that account instead of withdrawing from it. You should plan to repay this loan with interest on a specific schedule, generally within 5 years.
However, 401(k) loans have unique costs and risks compared to other loans. The money you borrow from your 401(k) won’t grow while it’s not invested, and if you leave your job, you’ll typically need to repay the loan balance in full right away or risk having to pay income taxes on it.
Take advantage of a balance transfer credit card offer
If you’re primarily dealing with credit card debt, you may be able to transfer your balance to a different credit card with a low or 0% introductory or promotional interest rate.
Just make sure you can pay off the transferred balance before the low-rate period expires and the interest jumps to the standard rate.
Ask for help
Asking for support from friends, family or even a financial counselor or advisor could be beneficial. Even if you aren’t comfortable asking for a loan from friends and family, they might be a good sounding board.
A financial advisor may have other ideas for ways you could manage your debt. You can also contact your creditors to see if you can negotiate lower payments or find another solution.
Carefully weigh all your options
If you have a lot of debt, pulling money from your retirement savings account to help cover your financial needs may seem like a quick fix.
In very rare instances, this may be a feasible option. However, it’s generally best to consider other methods for paying down debt before compromising your retirement savings.
Ask yourself hard questions, think through your short- and long-term financial goals and the pros and cons. Seeing how you might be able to revise your budget and talking with your support system could also help, as could a debt consolidation loan.
