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Cashing Out My 401(k) to Pay Off Debt. Is It a Good Idea? – Paul

“Dear Paul,

I work for the federal government and make about $90K. My wife makes about 45K (no benefits) after losing her corporate job in 2003. I am 47 with an MS, she is 52 with a BS, married 23 years. I have to retire from my current job at 57 so we both know we will be working at least another 10 years, likely longer.

We have way too much debt. CC’s=35K, interest only HELOC 30K, cars=35K. Our house is break even at best as you can guess. We have one college age son, and a daughter approaching college. We have no reserve and live paycheck to paycheck.

I am in the camp that another recession is coming. I have 60K in my TSP(401K), she has 150k in an traditional IRA (401K rollover). Both just recovered from the huge losses taken in 2008. Upon retirement I will have a small pension 33K and SSI (maybe). My wife will have a insignificant pension benefit from her previous job and SSI (maybe).

I believe it is not impossible but rather likely that the the economy will worsen significantly in the next two years. My wife may lose her current job in home foreclosure auctions. There is already talk of furlough days for me next year. I firmly believe worse case scenarios or more likely than they have ever been in history.

It is possible the dollar will be devalued in the future, that it will no longer be the worlds reserve currency, that 401K’s etc may be seized by the gov’t and that all manner of horrific scenarios (as are currently playing out in Greece) are not only real, but all too real.

At the least, I believe the markets will drop again (Dow 8K or lower). Given my job, bankruptcy is not an option. How did we get here? See second sentence and we did not alter our lifestyle because of all the equity in the home, the markets etc. Things changed.

So, I have read many of your posts regarding using a portion of an IRA to pay off debt. Clearly you are against it and have stated why. (The money is for the future, growth potential, think about when you can’t work, need it to live when old, protected in bankruptcy, etc, etc.) These are all good points. But is every situation the same?

If the tax and the penalty of taking down a portion of the IRA is cheaper than the interest payments over the period of time it will take to pay off this debt and the IRA is likely to decline in value over the next few years anyway, I can take the money, pay off the debt, refinance the house to combine the interest only HELOC (ratios would be back in line), and then start pouring the money formally used to make all those payments back into a ROTH for her and maxinig out my TSP contributions for the next 10 years.

It seems like a solid plan that saves considerable money and relieves tons of stress. Why isn ‘t it? You may say that “you don’t know the furture and you may not be able to work as long or yadda, yadda, yadda” But I would say, nobody knows the future. The market may crash completely and there is no IRA. There might be complete economic breakdown and anarchy in the streets. One can only operate on what is known and likely and that is I will be working until sixty-something. Anyway, that is my position, I am not convinced it is the right thing to do or the wrong thing to do. Help.

John”

John

The bottom line on this is yes, about what you are saying regarding the benefits of paying off debt with your IRA, it may make sense if there are no other resources available.

Behavior modification should also be included as part of your plan, because if you do what you have described (cleaning up your personal balance sheet), you may not have the ability to do it again.

In other words, don’t fall into the trap of getting into credit card and other types of consumer debt a second time. Live within your financial means going forward.

You seem like you have a very good handle on what to do, given your unique set of circumstances. I wish you well in this regard.

Best of luck,

Paul

Cashing Out My 401(k) to Pay Off Debt. Is It a Good Idea?   PaulMr. Bennett is a Certified Financial Planner™ professional (CFP®), Chartered Financial Consultant (ChFC®), Accredited Investment Fiduciary™ (AIF®) and Managing Partner of c5 Wealth Management, LLC. He holds a Master of Science in Finance (MSF) with Honors from Indiana University – Kelley School of Business and a BA from the University of Florida. He is currently pursuing his PhD in Economics from SMC University. Mr. Bennett has completed the Advest Institute’s advanced program on portfolio analytics and behavioral finance at Harvard University.

He was recently recognized by Washingtonian Magazine as a Top Financial Advisor and Kiplinger’s Personal Finance Magazine, the Journal of Accountancy and the American Bar Association Journal as Who’s Who of Virginia Certified Financial Planner™ professionals. In addition, he has also been recently selected by the Consumers’ Research Council of America as one of “America’s Best Financial Planners”. He is a current contributor to the Rydex Advisor Benchmarking Index. He is quoted often in the press, has been featured on CNNRadio.com and has contributed to various publications such as U.S. News and World Report, Boomerater.com, Advisor Today, Dow Jones News, Financial Advisor Magazine, Financial Planning Magazine, Investment News, The Washington Business Journal and The Washington Times.

If you have a questions about investing, financial planning, retirement, entrepreneurship, executive benefits and insurance (life, disability, long-term care, etc.) you’d like for Paul to answer, just use the online form. The help is free.

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