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Should You Borrow from a 401K to Pay Off Debt?

If you’re struggling to make your minimum credit card payments or you feel buried under the weight of medical bills, you’re probably exploring your options to get out of debt. Some people choose to dip into their retirement accounts, but will this hurt you in the long run? We are exploring whether withdrawing or borrowing from your 401k to pay off debt is a smart strategy. 

Should You Take a Withdrawal from Your 401k?

First, let’s look at taking a withdrawal from your 401k to pay off debt. Especially for people in their 20s and 30s, this may seem like a great idea. After all, you aren’t retiring anytime soon and you can save more when you’re not putting so much toward bills, right? 

Before you start the withdrawal process, it’s important to remember that if you are below the age of 59 ½, any money you take out of your 401k is subject to a 10 percent penalty as well as your income tax rate plus fees. That means if you want $10,000 to pay off debt and you’re in a 22 percent tax bracket, you’ll need to remove around $17,000 to net the $10,000 you need. 

By keeping the money in your 401k, that $17,000 could be seeing an annual rate of return of between 5 and 20 percent each year. Over 25 years, that could be over $100,000 not including what is deposited during that time period. 

Should You Borrow from Your 401k?

Instead of a withdrawal, you can consider borrowing from your 401k. While employer rules do vary, generally, you can borrow a maximum of half the balance up to $50,000 and repay it over five years. The benefits of borrowing against your retirement are:

  • The interest rate is generally only a point or two over market rates.
  • The interest you pay goes back into your 401k.
  • You aren’t subject to taxes or penalties.

While this may be more advantageous than a personal loan, it’s not without risk. This is a potential option if you are 100 percent confident that you won’t be leaving your job (either willingly or not) for the time it takes you to repay the loan. If you default, it won’t hurt your credit, but you will be required to pay the taxes and penalties on the balance of the loan. You also lose out on growth to your investment. 

Other Options for Paying Off Debt

Most financial advisors highly recommend leaving your 401k alone instead of using it to pay off debt. Instead, if you would like to pay it off more quickly or get out from under a few bills, consider these options: 

  • Finding a side gig like Uber, Doordash, or babysitting to make extra money in the evenings and weekends. Even 50 to 100 dollars a week can knock out a medical bill or credit card payment in a few months. 
  • Sell some belongings that you aren’t using. Consider consigning clothes, selling old electronics that you don’t use any more, or, in more extreme cases, a vehicle with a high payment and high insurance costs. 
  • Look into debt consolidation that can lower your interest rates and monthly payments. 

In cases of high debt that you are struggling to pay off, filing for bankruptcy may be the right option. Your 401k is protected during bankruptcy and can’t be used to pay off creditors so your money is still growing for your retirement. 

Schedule a Free Consultation with a Bankruptcy Lawyer

If you are struggling with credit card bills, medical bills, and other debt, and you are unable to keep up with the payments, we can help. Schedule a free consultation with a bankruptcy lawyer in Florida today to learn about your options. Call us at (954) 922-2283 or fill out the form below to get started.

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