Work towards financial freedom with these six tips. The money is supposed to be earmarked for retirement; if you pull it out before then, you’ll pay income taxes and a 10% penalty. If it’s not, you’ll be forced to pay—you guessed it—a 10% penalty, plus taxes. Some people borrow from their 401k account for a downpayment on their primary residence. You usually have the option to pull money out of your 401(k) or take out a 401(k) loan. We will share with you all in this article. Is it a good idea to use my 401k to pay off debt? 1. I get it. If you paid your debt off with your retirement, it is easy to justify slowing down retirement to pay for a newer vehicle with a higher payment. I want to stress to you that taking out a personal loan or getting in the habit of borrowing money from your 401k is not a great idea. This keeps you motivated to pay the debt off as fast as you can, to free yourself from this position. So you go from paying others' high interest to paying yourself a lower interest.". Join 14,266 other email subscribers who are learning how to get out of debt and build wealth! Internal Revenue Service. Depending on the conditions of your plan, you may not be able to withdraw money from your 401(k) at all, or only in hardship situations without incurring the 10% additional penalty, such as for tuition or fees, significant medical expenses, purchasing a home, to prevent foreclosure or eviction, or for necessary home repairs.. You’ll want to look at other solutions first though. If your 401k plan is sponsored by your current employer, you can not access this money until you leave employment or suffer a major hardship. If you withdraw funds or take a loan from your 401k to pay your debts, there is no guarantee you fixed the problem that got you in debt in the first place. The biggest pro … Refer to The Best Way To Pay Off $10,000 In Credit Card Debt. Keep in mind that by taking out the $40,000 from your account, after the penalty you only received $36,000. Debt. Debt may be considered an eligible hardship case if it is allowed by your plan. Second, your take-home pay is less (because you have to pay back the loan) until the money’s paid back. With all the different reasons people give as to why they borrow or take money from their 401k to pay off debt, are any of them “good ideas?”. The more money you have in your retirement account, the faster it grows. LendingTree connects you with lenders who offer personal loans from $1000 to $50,000. Determining Withdrawal Eligibility With high debt levels, it's tempting to withdraw 401(k) plan funds that seem to be sitting around collecting dust until retirement. Please subscribe to my blog below by email so you don’t miss any posts. The following are qualifying exemptions: **Be sure to check with a tax professional before taking money out of your 401k plan to ensure tax laws have not changed. Paying off debt with 401(k) money when you are younger than 59½ will cost you some combination of interest payments, taxes and penalties, depending on how you access your retirement funds. Debt levels in the U.S. are notoriously high, from student loans to credit cards. By pulling from your 401k account to pay off debt, we are assuming that you will contribute back to your 401k loan aggressively. How long will it take to replenish what you took out of your 401k plan, to include the 10% penalty? Using a 401k Loan to Pay Off Debt. The idea is that you gain momentum along the way, much like a snowball rolling down a hill, and eventually pay off the largest debt. 1. In addition to not having to pay taxes, the interest charged on your 401k loan actually goes back into your 401k account. According to the IRS, a major hardship withdrawal can be defined as: Refer to the IRS website for all qualifying events. While your debt may have seemed insurmountable, can you afford to pay the taxes on your distributions in one year? I am proud of how far you have come, even if that means you have only read this article. According to The Debt Payoff Playbook, retirement contributions should be paused until you tackle your debts. You contemplate taking out $45,000 from your 401(k) to pay off credit cards with an average interest rate of 20%. Taking money out slows down your snowball – considerably. In addition to the repayment rate, you do not suffer a 10% penalty by taking a loan out on your retirement as you would pulling it directly out. Generally, the IRS relies on the employer to ensure the employee takes distributions related to the hardship. If you skip this step and jump straight to using your 401(k) savings to pay down debt, you're not fixing the root of the problem and will likely … In sticking with our earlier $40,000 withdrawal, let’s be optimistic and assume it only takes you 5 years to replenish your fund. We also reference original research from other reputable publishers where appropriate. "Retirement Topics - Exceptions to Tax on Early Distributions." Related: Using Your 401k to Pay Off Debt Ultimately, you'll probably have to take a look at what's happened in past years, take a guess about the future and go with your instincts. LendingTree connects you with lenders who offer personal loans from $1000 to $50,000. So if we want to get into semantics, you threw $4,000 out the window as well. Dear Dave, My wife and I have our fully funded emergency fund in place, and we're debt-free, except for the house. One option for uncovering a large sum of money may be waiting for you in your retirement account. 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