Steve Writes In “I Want to Cash Out My 401(k) And Pay Off Debt.”

Posted by Steve Rhode

September 22, 2008

Steve wrote me through the GetOutOfDebt.org site to ask his question below. You can too!

“Dear Steve,

I currently make $46,000.00 per year with no benefits. My wife’s income is $19,800.00 per year. Three years ago her income was $35,000.00 per year.

We have racked up about $20,000.00 in credit card debt and have a car loan of which the pay off is $15,199.00. Our 5 year old home is appraised at $158,400.00 and we owe $120,000.00 on it. No other debt. We have a small 401k of $39,550.00 and am losing between $200.00 and $500.00 a month on. We are 59 years old.

I want to cash our 401 in and pay off the credit cards and what I can of the car. We would start paying back out retirement at $600.00 per month.”

Dear Steve,

One of the key factors here is that you purchased your home and based your expenses on what your lives were like five years ago. Apparently two years latter there was a change in income for your wife and it was at that time that things probably begin to silently slip and the credit card debt started to increase to help make ends meet.

The 401(k) plan feels like your cash sitting in the bank and at a time of stock market upheaval watching the value slowly decline is painful, for sure. But the stock market will rebound over time and those funds will go back up.

If you tap those funds now you would probably have to pay a penalty of 10% of the value of the funds on top of your normal income tax rate. That means that you could cash out your retirement fund right now and walk away with around $26,000, losing around $13,500 to taxes and penalties.

With that $26,000 you should probably pay off your car loan first and then half of your credit card debt. While you say it is possible, I remain skeptical that you would be able to start saving $600 a month after that.

Depending on how much your car payment is, your credit card minimums are probably around $400 a month. That might reduce your expenses by around $850 a month. That little bit of breathing room might just be enough to help you make it from month to month but if you can’t make your monthly contribution back into the retirement account you could wind up in worse shape.

So while the plan is to put $600 a month back into the retirement plan, in six years when you reach 65 you’ll have about $43,200 in your 401(k), more or less.

Now, all of that being said, it might be beneficial for you to cash out your retirement plan as long as you retire the car debt, half of the credit card debt, faithfully add the funds back into your retirement account and don’t suffer any future reduction in income.

It’s a gamble but really only you can decide if you want to take the risk.

Big hug.

Steve

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