Ask an Advisor: I’m 40 and thinking about taking my 401(k) out to pay off some high interest credit card debt. Is this a good idea?

Ask an Advisor: I’m 40 and thinking about taking my 401(k) out to pay off some high interest credit card debt. Is this a good idea?

First, it’s important to consider all your options when evaluating how to pay off your high-interest credit card debt.

You will want to write out each option, the monthly payment, important notes or fees to be aware of, and how long it will take you to pay off the debt.

For example, the 401(k) option could be a loan if you have a current 401(k). There are some restrictions, so you will want to talk with your HR department to know the interest rate, monthly payment, number of payments, and anything else to be aware of. Keep in mind it is a lot harder to save than to pay off debt. So using your savings, especially an emergency fund may not be a good idea, it depends.

If you have an old 401(k), then you would be looking at a withdrawal, which will most likely be taxable, and since you are under 59.5, then you would face a 10% penalty on the withdrawal. Figure out your marginal income tax bracket. If it’s 22% + a 10% penalty + state income tax then you are potentially on your way to a 32%+ cost for taking out your 401(k).

Other options to consider are:

• Savings, which could include Cash Value Life Insurance and/or Taxable Investments.
• Personal loans, credit card balance transfers, home equity lines of credit, family loan, and/or secured/margin debt.
• Speak with your credit card company to learn about their fees and processes.
• Research debt consolidation companies and learn about their fees and processes.
• Selling valuable household goods that you do not use anymore could help reduce the debt.

Be open to using multiple strategies to pay off the debt.

For example, let’s say you owe $20,000 in credit card debt at 22% interest. That means that each month, you are paying ~$367 in interest, which equals ~$4,400/year. Your minimum payment on the credit card is probably at least $400/month which means only $33/month is helping to reduce the debt.

Withdrawing your 401(k) could cost (as an example) 32%, which means you would need to take out $29,415 in order to have enough to pay off the debt. So taking out the 401(k) will cost you ~$9,415 in taxes, which is more than double the interest from your credit card in a year! But once the 401(k) withdrawal is done then it frees up your cash flow by at least $400/month. It’s still an expensive option though, so it’s best to keep looking.

If you can qualify for a personal loan, then maybe your interest rate is 15%. If the term is for 5 years, then your payment is probably around $476/month. It’s probably higher than your minimum credit card payment, but at least it saves you $1,400/year in interest compared to the credit card. It might be difficult to qualify since $20,000 on a credit card is probably high credit utilization, which means it would have dropped your credit score.

Maybe you have another credit card with a credit limit of $12,000 and a $0 balance. Check to see if you have a balance transfer option with a 0% interest promotional rate. In that case, you could transfer $12,000 from the $20,000 to the new card for, let’s say, a fee of 4% ($480). You then have 12 months at 0% interest on that $12,000. This saves you at least $1,920 in credit card interest and gives you 12 months to figure out how to pay off the higher-interest card first. You would still have the 401(k) withdrawal option if it made sense at a later date.

The reality is that the 401(k) option typically is a more expensive way to pay off high interest debt. It will take work to figure out how to reduce your interest and the debt. It will take cash flow, savings, and restructuring of your debt to save money. But, the more you reduce the interest, the more money in your pocket so you can achieve your most important goals! Good luck!

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This article is intended for informational purposes only and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.

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