Should I Cash Out My 401k To Pay Debt?

by Dual Income No Kids on August 6, 2009 · 0 comments

The short answer is: NO!!

There are a ton of fees involved in early distributions from retirement accounts. If you cash out your 401k to pay off a debt, you’ll get hit with up 35% tax on principal that you take out of the account. You’ll also get slammed with a 10% early withdrawal fee (if you are under 59 and 1/2). Finally, you may also have to pay a redemption fee to liquidate the securities held in your account. Finally, there is an opportunity cost as well. Even if you’re using the money to eliminate good debt, like a mortgage, you’re still denying yourself valuable opportunities to allow your money to compound.

There is some wiggle room. If you cash out the funds, you’ve got 60 days to put it back. There are also some exceptions to the 10% withdrawal penalty.

1. Purchase of a primary residence
2. To avoid foreclosure of, or eviction from, primary residence
3. Payment of secondary education expenses incurred in the last 12 months for the employee, his/her spouse, or dependent(s)
4. Medical expenses not covered by insurance for employee, their spouse, or dependent(s)
5. Funeral expenses for the employee’s deceased parent(s), spouse, child(ren), or dependent(s)
6. Home repairs due to a deductible casualty loss (as of December 31, 2005)

Even if you can organize one of these loopholes, you still get stuck with the income tax hit and miss out on chance to compound your money.

Bottom line: don’t cash out your 401k. Instead consider other possible aggressive debt reduction strategies or possibly taking a loan against your retirement accounts.

Best,

James

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