Should You Use Retirement Savings to Pay Off Credit Card Debt?

The interest rate on credit cards across the United States is currently at a record high, resulting in many people having to pay more than ever before in monthly fees for their outstanding balances.

Many people are considering if it would be beneficial to use their retirement funds to pay off their debt.

A lot of individuals have the majority of their financial savings in their job-related retirement plans due to the fact that they were automatically signed up for them, and their employer may even match their contributions.

Personal Finance has reported on the potential consequences of a Supreme Court ruling against student debt relief, the progress of the Secure 2.0 bill to improve the retirement system, and the issue of retirement legislation that has yet to address a "huge problem."

When it comes to paying off credit card debt, individuals with a 401(k) workplace retirement plan have three main options. They can opt to take a withdrawal from the account, borrow from it, or temporarily suspend their contributions.

It is important to understand the details of the three available options.

If you withdraw money from a 401(k) account before you reach the age of 59½, you will be subject to a 10% penalty and taxes. This means that if you need $15,000, you will need to withdraw close to $24,000 to cover the charges, as reported by Fidelity.

When you withdraw money from an account, you will not benefit from any potential market gains. Historically, stocks have had an average annual return of over 10% over the past century.

According to Ted Rossman, a senior industry analyst at CreditCards.com, the advantages of using a credit card should be much greater than the average interest rate. In certain cases, there may be exceptions.

For those aged 59½ and in a low tax bracket, a 401(k) withdrawal to cover credit card debt may be a viable option, according to Allan Roth, a certified financial planner and the founder of Wealth Logic in Colorado Springs, Colorado. This is because they would not be subject to the 10% penalty or a large tax bill.

Roth asserted that the mathematics could make it worthwhile.

Rossman noted that for many people, there are more attractive alternatives to withdrawing money. He suggested that it might be a good idea to pause or reduce 401(k) contributions and use the money to pay off debt instead.

However, that advice should be taken with a grain of salt.

Experts suggest that if your employer offers a company match, you should aim to save up to the maximum amount, whether it is 3% or 5% of your salary.

Rossman pointed out that taking advantage of free money can often double the return on an investment.

Experts suggest that taking out a loan from your 401(k) plan is usually a better option than making a withdrawal. 401(k) loans usually have an interest rate that is lower than 5%, which is much lower than the annual rate of most credit cards. Additionally, the interest paid on the loan is put back into your savings instead of going to a bank.

Jessica Macdonald, head of editorial content at Fidelity Institutional, suggested that taking out a 401(k) loan to cover high-interest debt, such as credit cards, could be a way to reduce the amount of interest paid to lenders.

According to Macdonald, taking out a 401(k) loan has additional advantages, such as not needing to go through a credit check and not appearing as debt on one's credit report. It is important to take other elements into account as well.

When taking out a loan, you must be able to pay it back within five years. If you leave your job and are unable to repay the loan, it will be considered in default. This could result in taxes and a 10% penalty on the remaining balance. Additionally, your money will not benefit from any market returns.

Experts suggest that those who are considering using their 401(k) to pay off credit card debt should also reflect on the behaviors that led to the debt in the first place.

Roth noted that if someone withdraws funds to pay off their credit card debt and then spends more to increase the debt again, it will not have the desired effect.