Tanisha Wants to Cash Out 401K To Get Rid Of Debts.


“Dear Steve,

I recently recieved $137k into a 401k account from my ex-husband due to a divorce. I’m 35 years old, 2 kids, unemployed stay at home mother for past 8 years. I will receive spousal support until 2012. I no longer own any property or assets and I have $33,000 in credit card debts with interest rates ranging from 10%-18%.

With the stock market the way that is, I feel the need to cash out a portion of my 401k to pay off all debts. I understand that there’s a 20% tax penalty for cashing out and the 10% for early withdrawal is waived due to divorce.

Do you think that I’m making the right decision to cash out the 401k to get rid of the $33k in debts? The monthly credit card payments total approximately $750-$800 per month. If an emergency happens, I feel afraid that I don’t have extra cash around every month due to high credit card bills.

Should I cash out the 401k to get rid of the debts?


Dear Tanisha,

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Normally I am dead set opposed to using retirement money to pay off debts. But in your case, i may be willing to make an exception to that position.

Your situation is a little bit unusual in that you are an unemployed mother. It appears you have no money coming in except for spousal support and then this $137,000 401(k) windfall.

Normally I would suggest not touching the 401k money since it is there for your retirement and will grow to provide savings for you in the future. However, as an unemployed stay-at-home mom there is little chance of you repaying the $33,000 worth of credit card debt without finding a job and going back to work.

By paying off your $800 worth of credit card payments each month it will make it easier to get by on what little income you do have coming in, especially since that money will only continue for four more years.

The best case scenario is that you are able to find gainful full time employment and repay your credit card debt that way. Then you will be able to leave the entire $137,000 in the 401(k) and since the stock market is currently at very low levels, by the time you retire that investment will be worth a lot of money.

Outside of that you could consider bankruptcy, go bankrupt, discharge your credit card debt and leave the entire $137,000 in your retirement account. That would get rid of your debt and protect your 401(k) funds.

I think before you decide what to do you should discuss your options with a bankruptcy attorney. You can ask for a free bankruptcy review and use the session to become better informed about what your options are under bankruptcy to eliminate debt you cannot afford and protect money that is designed to take care of you when you get older. After talking to the bankruptcy lawyer you will truly be able to decide which path is best for you.

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Steve Rhode is the Get Out of Debt Guy and has been helping good people with bad debt problems since 1994. You can learn more about Steve, here.
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