Submitted by Rachel R on Wed, 03/14/2018 - 9:29am
Debt now versus retirement later
Image by geralt via Pixabay
Debt isn’t always a bad thing. It’s debt that lets you buy a house or a car – two things most Greensboro consumers could never purchase on a cash basis. If you can service your debt on your current income while still paying your costs of living and saving for retirement, you’re probably just fine.
For those living paycheck to paycheck, unable to save, and being hassled daily by collection agents, debt is awful. Should you tap into your retirement funds to pay off your debt? If you ask your creditors, they will tell you yes because they want their money, but it’s probably a bad idea.
In most cases, tapping into your 401(k) to deal with debt is a terrible prospect. That’s money you’ve set aside for your future when your income-earning days are behind you, and you’re ready to slow down. However, it can be tempting to dip into them if debt collectors are hounding you and your golden years seem too far away to cause concern.
Understand that if you touch your retirement funds to deal with current debt, you’re short-changing your future, and this could be one of the biggest mistakes of your life. It’s much better to tighten your belt, slash expenses, sell off assets, or take a second job before you touch your 401(k) to service debt – even if that debt is your mortgage or auto loan.
Apart from the fact that draining your 401(k) compromises your ability to support yourself when your best work years are behind you, there are significant penalties as well. The dollars and cents impact of pulling money out of your retirement account before age 59 ½ include:
That means that right off the top, for every $100 you access, you’ll have just $90 in your pocket. Then there’s the income tax impact. If you’re in a 15% tax bracket, that cuts your cash in hand down to $75. When you factor in the interest you’re losing over time, that 25% can feel more like 50-70%.
Would you take out a 50-70% interest loan to pay off your debt? Of course not. That’s essentially what you’re doing when you use retirement funds to service debt. However, there are a few exceptions for using 401(k) funds where you’ll pay income tax but avoid the 10% penalty including:
There is one method to use your 401(k) funds now to tackle debt without putting your financial future at risk, but it still has some downsides. Close to 20% of those with 401(k) accounts have a loan against their funds, and this can be a strategic move if done wisely.
Technically, it’s not a loan because there is no creditor involved in the transaction. In essence, you’re borrowing from yourself. You’ll pay back a bit more than you borrowed, but you’re paying it to yourself. Here are some of the benefits of a 401(k) loan:
The downsides to borrowing from your 401(k) are:
Consumers with overwhelming debt should consider all the alternatives before they dig into their retirement account. If you have a short-term need, such as a major car repair or a one-time medical procedure, it might not be so bad, but only under a loan scenario.
However, a better alternative might be to consider Greensboro bankruptcy. For those with mostly unsecured debt such as credit cards and medical bills, Chapter 7 can wipe those out in about four months, and your retirement funds will not be at risk.
For those with delinquent balances on their mortgage and auto loan, Chapter 13 can put you on a repayment plan to catch up on that debt while also seeing relief on unsecured debt. Plus, debt discharged in bankruptcy has no tax consequences.
Before you take funds out of your 401(k), talk to an experienced North Carolina bankruptcy attorney about your debt dilemma to see if bankruptcy might be a better option. The advice is free and could be life-changing.
To find out more about the benefits of bankruptcy, contact the Law Offices of John T. Orcutt. Read client reviews and then call +1-919-646-2654 to schedule a free Greensboro bankruptcy consultation at one of our locations in Raleigh, Durham, Fayetteville, Wilson, Greensboro, Garner or Wilmington.
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