by Maurie Backman | Updated July 21, 2021 - First published on Dec. 4, 2019
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Think twice before raiding your nest egg to eliminate debt.
Many of us carry debt, whether it comes in the form of a credit card balance or other loans. But if you're tired of wasting money on interest and having those payments hanging over your head, you may be tempted to take a withdrawal from your IRA or 401(k) to knock that debt out. After all, that retirement money is yours. Why save it for the future when you can make your life easier in the present? But while raiding your retirement plan to eliminate debt might seem like a good idea, you should know that there are much better ways to become debt-free.
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There are two issues with tapping your retirement fund to pay off debt. For one thing, if you take an IRA or 401(k) distribution prior to reaching age 59 1/2, you'll face a 10% early withdrawal penalty on the sum you remove. That's money you're effectively giving away to the IRS. Which is kind of like the interest you're tired of giving away to your credit card company or loan issuer.
The second problem with removing money from an IRA or 401(k) is that those funds are supposed to be earmarked for retirement, when you no longer have a source of income. If you take an early withdrawal, you'll risk not having enough savings when you're older and need that money the most.
As tempting as it may be to use some of the money you have in a retirement plan to pay off debt, there are better ways to achieve that goal. First, map out a budget. It will give you a good sense of what your obligatory expenses look like and where your money actually goes month after month. Once that budget is in place, comb through it and identify non-essential spending categories you're willing to cut back on. Common choices include cable (do you really need all those channels anyway?), rideshares, restaurant meals, and gym memberships. Spending less in these areas will put you much closer to shedding the debt you've accrued.
Another good solution for paying off debt? Get yourself a second job. The money you make won't already be earmarked for existing bills, so you'll be able to take every dollar you bring in and apply it to your loan balances (minus what you owe the IRS for taxes on those earnings, of course).
Finally, be smart with windfalls. If you get a cash bonus at work for your solid performance, a generous birthday or holiday gift from a relative, or a sizable tax refund, don't spend that money. Rather use it to eliminate your debt.
Raiding a retirement account might help you pay off debt quickly, but it could set the stage for financial ruin once you're older, not to mention cost you money in the form of early withdrawal penalties. You're far better off cutting back on expenses, boosting your earnings, and managing cash influxes wisely to chip away at that debt until it's gone.
One more thing -- if you can make your debt more affordable, it'll be easier to pay off, so to this end, see if it makes sense to refinance. You can refinance your credit card debt by rolling it into a new loan, or transferring your balances to a new credit card with a lower interest rate. Both options will lessen the amount of interest you pay and hopefully help you shake that debt sooner rather than later.
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