I recently got married and our combined debt load is significant, but manageable. I am able to put a little into savings each month, and I do have a small emergency fund.
I am 30 years old and have been putting into my company 401k for more than 7 years. I am currently putting in 6% of my pay (the minimum to get my full company match of 4%), but would like to put more in.
I have a $10k loan out against my 401k that I used as a down payment on a house a couple years back.
My wife has an IRA with about $12k in it. Each year, she is given $2k to invest however she wants. Over the past few years, she has used that money to pay off debt rather than putting it into her IRA.
I have made a strong push to reduce or eliminate a lot of our debt. Most of it is now low interest (<7 or 8%), except for one remaining credit card that has an 18% interest rate. The balance on that debt is about $7k. I do not have room on lower interest cards to do a balance transfer. Would it be acceptable to cash out my wife's IRA to pay off the high interest debt? Considering the 10% penalty and taxes that will have to be paid, I figure I would be left with about $7500, which would pay off the high interest debt and give me an extra $200 per month. I could then increase my 401k contribution by 5%, which would give me far more benefit over the course of 30 years. Furthermore, we could pay the $2k that my wife gets each year on the 401k loan to pay off the loan much quicker and build up my 401k. I am tired of having debt, and would like to get it paid off as quickly as possible. I see this money sitting in her IRA, small enough to not amount to anything substantial in the future (loosely speaking, of course), but large enough to make a huge difference now and for the future. Any assistance you can provide would be greatly appreciated. Thanks! James"
I applaud your efforts to get out of debt. Congratulations on embarking on that journey. And a double kudos for maximizing your investment contributions at your employer. You’ve done a lot of things right.
I’m not a huge fan of cashing out or borrowing against retirement accounts.
For example, if we assume a 5% rate of return on that IRA, if left alone for the next 35 years it would be worth $66,192.
The real question is if you took that money out, would you have the the discipline and ability to reinvest again to replace that lost investment at the rate of $58.26 per month. That’s what it would take over the same 35 years to get you to the same end point.
But probably the most important question to ask here is if you cash out the IRA and pay off the higher rate card, will you be able to stay out of debt and keep your obligations affordable?
I’m always a fan of maximizing retirement savings but I don’t want you to do it at the expense of shorting your emergency fund. I’m concerned by your statement you have a “small emergency fund.” I’d like to see that become a large emergency fund before you stash more cash into an investment which is hard to tap if you need the money, like with a 401k loan.
When you borrow from your 401k you have to repay it with a low interest rate, which seems great, but you also lose the earning power of that money while it is withdrawn and in case of a separation from your employer the entire loan can be due on demand.
I’m not saying you should not cash out the IRA but what if you took a look at getting an unsecured debt consolidation loan from either LendingClub.com or Prosper.com first? That way you’d be able to wrap all your debt into one, hopefully lower, payment and protect the IRA. If anything, at that point you could use the IRA to pay off the 401k loan if you just could not resist cashing it out.
Check out either or both of those peer-to-peer lenders and let me know if that makes sense to you.
With this approach you could use part of the $2,000 annually to payoff the consolidation loan early, part to stick in your emergency fund, and part to blow and have a good time.
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