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Home > Ask The Get Out of Debt Experts > I’d Like to Cash Out My 401K, Get a Home Equity Loan and Reinvest it in an IRA. – Rik

I’d Like to Cash Out My 401K, Get a Home Equity Loan and Reinvest it in an IRA. – Rik

Rik

“Dear Steve,

Hi Steve, you’re a good guy for helping so many people.

We have $90,000 credit card debt all at %25, about 1/3 from unwise spending, the rest from medical bills, and taxes we couldn’t pay due to medical bills. I have been fighting minimum payments for years and years and can’t do it anymore. Our balances keep going up. We have somewhere near 100,000 in equity in our home but can’t get any kind of a loan due to too much debt (+fighting ID theft ).

We also have 110,000 in an old 401k. I am 45, our take home income is 8000.00 per month, our bills (minimum pmts) are 8000.00 per month including food/gas/everything else. I am self employed and will either lose my contract in one month, or if I’m lucky I’ll be recontracted at a reduced rate. (newspaper distributor, bleak future)

At this point, I want to liquidate the 401k to pay all the debt. The plan is to use the 60 day period to first pay all the debt, then get the equity loan which we will then qualify for, to reinvest the 90k in an ira. If I lose my contract we can still make it under this scenario. I don’t want to do a bankrupcy, my credit score was 790 18 months ago.

Should I go forward with my plan? Or do you think there is a viable alternative?

Thank you very much!

Rik”

The Answer

 

Dear Rik,

I must admit that I rarely think it is wise to clear out a 401k to pay off debt. Even though the market is in bad shape right now, the money will grow again. You’ll never be able to return yourself to the investment position you are in today with a future of no job or a reduced income stream.

As long as you leave the money in the 401K it is safe from your creditors taking it. Let me present an alternative scenario here for you to consider.

Let’s say you clear out the 401K and get $80,000 after penalties and tax withholdings. It’s not going to be enough to clear off all of your debt. You’ll probably live off some of that money for a couple of months and by the time you go to pay off the $90,000 of old debt you’ll have about $75,000 in cash to do it with.

If you then tried to clear out the old debt with debt settlement, that will trash your credit. So you use the $75,000 and pay off some of the old debt. You’ll be left with about $15,000 of debt still to repay.

On top of that, your future is a bit up in the air. You’re right, it is not a great time to be in the newspaper distribution business. If you lose your job then you’ll be scrambling to find a replacement income. It is possible that you’ll wind up unemployed or under-employed for some time. Even if you get a new contract, at a lower rate, you’ll still have about $300 a month in residual credit card payments for the residual $15,000 in debt that could not be paid off. This on top of your new reduced income might not be leave you with enough for you to get by.

If you find it tough after cashing out the 401K and paying off what you could, you still don’t sound like you have much of an emergency fund to fall back on to get through some potentially tough times. All tapped out with nowhere to go. Now, you’ll have $0 in your protected 401K, your debt won’t be fully paid off, you will be under-employed or unemployed and have no financial emergency fund to tap.

I think your plan is logical if you are only looking at today or this week but if you look ahead just a bit I think that cashing out the 401K is a risk that I personally would not be comfortable with approving.

My advice is for you to wait to understand what is going to happen with your job before you do anything. You’ll know soon enough. Even if that means missing a payment in the short-term.

Does that seem like a reasonable approach for you?

Please let me know what you decide to do.


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About Steve Rhode

Steve Rhode
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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