“Dear Steve,
We have about $35,000 in current debt not including a home that is not finished. We have about $120,000 in IRA money. We own $75,000 in real estate free and clear that is for sale but not sold yet. Should we liquidate some of the IRA money to help out our debt?
Christine”
Dear Christine,
The interesting thing about helping people with debt problems and to get out of debt is that no two situations are ever the same. Recently Steve wrote in and asked me a similar question about borrowing from his retirement account. You might want to review that Q&A to see what I also told him. The advice I give you is probably going to be different.
It is hard for me to consider borrowing retirement funds as a good thing to do. I am a firm believer of putting money into IRA and 401(k) accounts and leaving it in there to grow. While it is in there it might require some readjustment of the mutual funds it is invested in but taking it out is almost always a mistake.
I say almost always because I have advised some people to do it in certain situations and I could see myself doing that if I was in a really bad situation as well.
The times that I have suggested borrowing from the IRA are usually when there is a critical situation that would be fully resolved by borrowing the money. One example was when this couple came to me for help and their newborn son had just died and she was now out of work. The husband had been diagnosed with cancer and was having to drive 200 miles each way for special treatment. The cost of the treatment, his time off work and the gas, plus funeral expenses had deflated their bank accounts.
With everything going on they fell behind on their bills. They owned a house and had about half of it paid off. Capital One was coming after this guy really hard for about $65,000 and he didn’t have it. He looked into refinancing their house to take cash out but he could not find a lender.
He had about $50,000 in his IRA and after fees and penalties he would wind up with about $37,500 if he cashed it out. I told him that if he could get Capital One to agree to settle the debt for that amount he would avoid bankruptcy, putting his home at risk and he could retire this debt once and for all.
Capital One refused to accept less than $43,000 and we talked about it on the phone. He was bummed, I was depressed and even the story and documentation would not persuade Capital One to accept his entire IRA as a settlement.
He called me the next day. Seems that when he got home he opened the mailbox and in it was a letter from a different department at Capital One agreeing to accept $25,000 as a full and final settlement. Just goes to show you that big creditors don’t have a clue what other departments are doing or saying.
He took the offer, cashed out most of his IRA and paid off Capital One which saved his house and it gave them tremendous peace of mind.
But Christine, that does not sound like your situation and in your case, based on what you’ve told me I’d say that you should not tap your IRA to pay off your debt.
It sounds like our primary issue here is that we are waiting for the home to sell and when it does you’ll have enough cash to pay the cards off completely.
If you rush to cash out or borrow from your IRA it will be very difficult to return yourself to the same position you are in today. With the stock market in the sewer as I write this the value of your IRA is probably off by a large amount. If you sell now you will get less for your shares than if you hold on to them and let the market come back.
If you take out $35,000 and before you can repay that money the market starts to climb again the same amount of shares will cost you more and maybe a whole lot more. And if you can borrow from your IRA and pay it back at a low interest, say 5%, it actually costs you a whole lot more than that. You’ll have to pay the 5% plus lose the increase in value of those stocks you would have got if you left those shares alone.
If the market rebounds and your IRA goes up 15% in the next year or so then it doesn’t cost you 5% to borrow, it costs you 5% + 15% = 20%. That’s expensive.
Generally you are always better leaving the IRA money as ‘off limits’ except in rare circumstances.
Let’s do this, let’s revisit the situation in a couple of months and take a second look at your situation then if things have not changed with the house.
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