Using 401k to pay off credit card debt

[Juddog]

Question to the financial saavy amongst the ATOT crowd: Looking at my latest 401k statement, I noticed that this latest quarter my portfolio actually decreased in value.

Someone I know mentioned to me that you can borrow against your 401k to pay off other bills if it's needed; is it worth doing this to pay off credit card debt?

In other words, say you have $3,000 in 401k, and $3,000 in credit card debt, for instance if I borrowed against the 401k to pay off the higher interest credit card debt.

 

[Reckoner]

That's a bad idea.

Don't hit up your retirement savings unless it's an emergency, and you have nowhere else to turn. Instead, look for a 0% balance transfer offer out there, and transfer your CC debt to that.

 

[child of wonder]

No.

Do as Paul says and look for a balance xfer option, then pay off ASAP.

 

[PepePeru]

I always thought it was a rule that you should be debt free before investing...
well, if not, it should be.

i realize there are places that force you to put $ into a 401k or whatever, i used to work for one.

 

[Drakkon]

bad idea

401k is untouchable by bankruptcy and therefore should never be used for anything other than to MAYBE buy a house. Just continue to pay off debt adding extra whenever you can. Scrimp, save, and destroy all cards so you wont charge any more on them.

 

[JS80]

Worst idea EVAR.

 

[JTsyo]

Don't think the OP is talking about removing the assets from the 401K but taking a loan from it. My retirement plans offers such loans, 5K for general or much higher for buying a house. If your 401K isn't making money, that might not be a bad idea since you'll pay it back with interest and your interest should be around a bond rate.

 

[DisgruntledVirus]

Originally posted by: G Wizard
I always thought it was a rule that you should be debt free before investing...
well, if not, it should be.

i realize there are places that force you to put $ into a 401k or whatever, i used to work for one.

The sole exception is when an employer matches money saved. For example my employer gives up to 5% match and between $.5 and $1.5 on each dollar I invest depending on our performance. Last year that gave me an additional few thousand dollars of "free money" so to speak.

If your company does a matching, check to see if pulling money out will cut the matching or anything.

I also am interested in this because I could pay off my car real soon if I did, but don't want to hurt my 401k if it's better to just pay it off normally.

 

[Juddog]

Originally posted by: DisgruntledVirus

Originally posted by: G Wizard
I always thought it was a rule that you should be debt free before investing...
well, if not, it should be.

i realize there are places that force you to put $ into a 401k or whatever, i used to work for one.

The sole exception is when an employer matches money saved. For example my employer gives up to 5% match and between $.5 and $1.5 on each dollar I invest depending on our performance. Last year that gave me an additional few thousand dollars of "free money" so to speak.

If your company does a matching, check to see if pulling money out will cut the matching or anything.

I also am interested in this because I could pay off my car real soon if I did, but don't want to hurt my 401k if it's better to just pay it off normally.

Hmmm yeah that's a good point, my company matches up to 4 %.

Thanks to everybody above on the responses. Also to clarify I was referring to "borrowing" from the 401k account as opposed to withdrawing funds.

 

[Fritzo]

Originally posted by: G Wizard
I always thought it was a rule that you should be debt free before investing...
well, if not, it should be.

i realize there are places that force you to put $ into a 401k or whatever, i used to work for one.

Yeah, damn those stupid businesses looking out for your future and all...

Anyway, if you borrow against your 401k, your paycheck gets garnished for the monthly payment. If you can't pay off your credit card, what makes you think you can pay back your 401k?

Also, that 3g's can end up costing you 100g's in retirement funds when you're 63. Leave it alone and stop buying crap if you want to pay off the card.

3000 isn't that much, shouldn't be too hard.

 

[Pantoot]

Originally posted by: JTsyo
Don't think the OP is talking about removing the assets from the 401K but taking a loan from it. My retirement plans offers such loans, 5K for general or much higher for buying a house. If your 401K isn't making money, that might not be a bad idea since you'll pay it back with interest and your interest should be around a bond rate.

It still would be a bad idea, if something happens to his job the 401k loan would be due in full.

 

[Reckoner]

Originally posted by: Juddog

Originally posted by: DisgruntledVirus

Originally posted by: G Wizard
I always thought it was a rule that you should be debt free before investing...
well, if not, it should be.

i realize there are places that force you to put $ into a 401k or whatever, i used to work for one.

The sole exception is when an employer matches money saved. For example my employer gives up to 5% match and between $.5 and $1.5 on each dollar I invest depending on our performance. Last year that gave me an additional few thousand dollars of "free money" so to speak.

If your company does a matching, check to see if pulling money out will cut the matching or anything.

I also am interested in this because I could pay off my car real soon if I did, but don't want to hurt my 401k if it's better to just pay it off normally.

Hmmm yeah that's a good point, my company matches up to 4 %.

Thanks to everybody above on the responses. Also to clarify I was referring to "borrowing" from the 401k account as opposed to withdrawing funds.

I still wouldn't do it. You'd take a tax hit on the distribution. You're better off looking for a 0% BT offer.

 

[newmachineoverlord]

With a bigger debt problem it would have been a good idea about ten months ago, before the market dropped. Then you would effectively be borrowing when the value was high, and then buying back when the value was low. The biggest downside is that if you lose your job, you get a 10% penalty on it, and it's that risk that makes it a bad idea in general. In the low amounts you mentioned, $3000 is an amount you can easily get a low interest credit card balance transfer on if you have a job with a 401k and no other debt. But say you had ten times as much, $30000 in credit card debt at $30% interest. Borrowing against the 401k would reduce your interest rate substantially, and there's no way that the appreciation in the 401k is going to beat 30%. Some will say that the downside is that you have to pay back the 401k with after tax money, but that's true of private loans and credit cards too so it isn't really relevant to the issue.

Also you should be debt free before investing beyond the employer matching. You should always max out the employer matching contribution, as long as the percent matched exceeds your interest rates.

 

[skimple]

I think the 0% balance transfer, if you can qualify for one, is the best way to go. However, the 401k loan deserves some discussion, as it could be a good option if you can't get a 0% balance transfer.

The first thing to compare is what return rate you get on your 401k. I realize that most people's accounts are down right now, but you need to consider the whole term of the loan. This depends on your investment strategy. The normal rule of thumb is that the stock market returns about 10% per year over time. This year you may be down 10%, but next year you could be up 20%, or down another 5%, who knows? But lets assume a 10% return over a four year loan, which is the normal pay-back term on a credit card. So, by taking money out of your 401k, you are "paying" 10% per year in terms of forfeiting interest.

Now, if you are paying 18% on your credit card, by paying off your card, you would theoretically be saving a net 8% per year in interest,.. If your 401k return drops to 0%, you are saving 18% per year. If your 401k return grows to 20%, you are paying 2% more than you would have paid the credit card company.

In reality, this is an investment gamble. If you think your 401k will perform poorly over the next 4 years, you could save yourself a lot of money by doing this. If your 401k grows rapidly, you would be losing a lot of interest.

Another important note is that you will pay yourself interest on the loan that you take. Let's say that your loan rate is 8%. Although this money goes back into your 401k account, it reduces the net cash savings that you will see between your credit card payment and your 401k loan.

If my credit cards were at 18% or higher, I would consider doing this. But in general I agree that moving to a 0% balance transfer will probably get you the best return for your money IF you can manage to roll the debt to another 0% balance transfer before the grace period expires, or IF you can pay off the whole amount before teh grace period expires, or IF the card you are moving to will give you a lower interest rate once the grace period is over.

 

[dullard]

In a perfect world, borrowing can be a good option. If you are paying a higher rate on your credit card than the rate you get on your 401k investment, then mathematically borrowing is better financially.

However, there are some pretty big potential hurdles.
1) Some plans won't let you borrow, so this option isn't always available.
2) If the rate on the investment is higher than the rate on the credit card, then you lose money doing this. You can never predict the return that you'll get in the future, so this is always a gamble.
3) You MUST pay that loan back on time, or you pay income tax + 10% penalty.
4) If you are fired or if you quit, the money is due immediately.
5) This feeds your bad behaviors. You spend too much, that is why you have credit card debt. Borrowing money (even from yourself) only encourages you to spend more which reinforces your bad behavior. With reinforced bad behavior, do you honestly believe you'll repay the loan? Think about it, and be honest with yourself.

The combination of #3 and #4 can be brutal. Suppose you are fired. Right at the time that you have no income you either (a) have to pay all that money that you borrowed when you have no money to pay it or (b) pay a massive fine and extra tax and have no retirement savings at all. Neither one is a good thing when you have no job.

So, yes, you can gain by borrowing from your 401k, but you are taking a big risk. The amount you gain depends on how the stocks do. You are basically betting that stocks will drop, be flat, or have a minimal gain. If that is true, you can gain ~$1000 by borrowing from your 401k. If stocks suddenly do well, you could lose far more than $1000. Or if you are fired or want to move jobs, you could lose far more than $1000.

 

[SearchMaster]

Originally posted by: dullard
In a perfect world, borrowing can be a good option. If you are paying a higher rate on your credit card than the rate you get on your 401k investment, then mathematically borrowing is better financially.

However, there are some pretty big potential hurdles.
1) Some plans won't let you borrow, so this option isn't always available.
2) If the rate on the investment is higher than the rate on the credit card, then you lose money doing this. You can never predict the return that you'll get in the future, so this is always a gamble.
3) You MUST pay that loan back on time, or you pay income tax + 10% penalty.
4) If you are fired or if you quit, the money is due immediately.
5) This feeds your bad behaviors. You spend too much, that is why you have credit card debt. Borrowing money (even from yourself) only encourages you to spend more which reinforces your bad behavior. With reinforced bad behavior, do you honestly believe you'll repay the loan? Think about it, and be honest with yourself.

The combination of #3 and #4 can be brutal. Suppose you are fired. Right at the time that you have no income you either (a) have to pay all that money that you borrowed when you have no money to pay it or (b) pay a massive fine and extra tax and have no retirement savings at all. Neither one is a good thing when you have no job.

So, yes, you can gain by borrowing from your 401k, but you are taking a big risk. The amount you gain depends on how the stocks do. You are basically betting that stocks will drop, be flat, or have a minimal gain. If that is true, you can gain ~$1000 by borrowing from your 401k. If stocks suddenly do well, you could lose far more than $1000. Or if you are fired or want to move jobs, you could lose far more than $1000.

#5=ding ding ding

I think Dave Ramsey says that statistically the average person who borrows to pay off CC debt (against house, 401K, bank loan, etc) has their CC balances right back where they were within 18 months.

 

[imported_Lothar]

Originally posted by: JTsyo
Don't think the OP is talking about removing the assets from the 401K but taking a loan from it. My retirement plans offers such loans, 5K for general or much higher for buying a house. If your 401K isn't making money, that might not be a bad idea since you'll pay it back with interest and your interest should be around a bond rate.

The IRS will still tax any interest earned on the loan at your income tax rate.

http://finance.yahoo.com/focus...k)?mod=retirement-401k