Should I Use 401(k) Funds to Pay Down My Debt?

With the recent economic times, I’ve come across a surprising number of people considering using their 401(k) funds to pay down debt. I don’t want to leave you with a simple “no, you shouldn’t do that” and skip a good discussion on why or what your options may be. So here goes…

If you are under age 59 ½ and withdraw money from your 401(k) you will face high fees. You will lose 35-45% of the withdrawal to taxes and penalties.  Of course that is a high percentage and may give you pause, but you might think it’s worth it. You need to consider whether the fees you are charged to take out that money will be more or less than the interest you are paying on your debt. It is very likely that the interest you will pay on your debt is not enough to counterbalance those high fees. Translation = you would lose money by paying down debt with your 401(k) funds.

So what can you do? You may consider reducing the amount of money you are currently contributing to your 401(k) and putting that amount towards your debt. Then once the debt is paid off, be sure to start putting those funds towards your 401(k) again. If you can, though, make sure you are at least contributing up to the amount your employer will match, if they match contributions. You don’t want to leave free money on the table. But that’s a topic for another day.

Occasionally using your 401(k) funds may be beneficial. For example, you may be able to take a loan on your 401(k) to purchase a rental property that will bring in more income. I’ve often mentioned the benefits of generating alternative income, and in some cases (like the rental property purchase), it may be wise to use 401(k) funds. It is important to know the rules for 401(k) withdrawals or loans though, so make sure you do some research or talk to a financial advisor first.

If you are looking for a PROVEN debt elimination system be sure to check out the iMoneyCoach Debtinator! (http://store.imoneycoach.com/Debt_Elimination_Work_Book_p/debt%20elimination%20work%20book.htm) We’ve worked with hundreds of people using this system to help them get out of debt and stay out of debt. That last part is something most debt-elimination systems do not provide, which is why people end up back in debt, often worse than before.

Tags: 401(k), debt, debt elimination, matching