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Should I Liquidate My 401(k) In Order to Pay Off My Credit Cards?

By JLP | March 8, 2010

I was talking with a friend of mine the other day. He asked me whether or not he should liquidate his 401(k) in order to pay off his credit cards. Here are some of the details:

• credit card debt around $15,000. Interest rates of 19% and higher.

• 401(k) balance of $16,000 from a former job. No other retirement savings.

• will not be able to contribute to his 401(k) until next year.

• he has an extra $1,000 per month that he could put towards paying down his credit card debt. (I’m not sure what he’s currently doing with the $1,000.)

Here’s what I told him to do:

1. DO NOT LIQUIDATE THE 401(K)! Why? Because nearly $5,000 would be lost to taxes and a penalty. Not only that, he’d be losing out on the future growth of his 401(k).

2. I would then commit to paying $1,500 (using the $1,000 mentioned above plus current credit card payment amounts) towards paying off the credit card bills. I did some quick math and found that he could have his credit card debt elimated by February of next year:

It’s amazing how quickly interest charges can come down as long as you pay a sizeable amount each month towards the balance.

3. Then, about that time his credit card bills are eliminated, he will be eligible for the 401(k). I would then contribute $1,375 per month to the 401(k), which is the current employee maximum allowed.

4. LEAVE THE CREDIT CARDS ALONE!

The main thing is to have a plan and stick to it.

Topics: Basics, Credit Cards, Financial Planning | 9 Comments »


9 Responses to “Should I Liquidate My 401(k) In Order to Pay Off My Credit Cards?”

  1. Ken Says:
    March 8th, 2010 at 12:08 pm

    I would also say don’t wait till the payment date to pay the bill. Pay as soon as the money is available to help lessen the cost of interest.

  2. Don Says:
    March 8th, 2010 at 12:51 pm

    Yes. Ken’s advice is very good.

  3. Evan Says:
    March 8th, 2010 at 3:02 pm

    19% IS A LOT OF INTEREST in today’s credit environment.

    Can he take loan from the 401(k) (probably not since you mentioned former 401(k)? Does he have a Life Insurance policy with some cash value? He could take a long from that at a MUCH lower rate.

  4. Jade Says:
    March 8th, 2010 at 4:33 pm

    I think your advice is solid. I often find myself getting off course financially by trying to get ahead NOW, instead of focusing on long term goals. It is important to remeber how quickly things can snowball to the good if you committ to a solid, workable long term plan.

  5. BG Says:
    March 8th, 2010 at 4:59 pm

    I’d lean against liquidating a 401k to pay off this debt (like JP) — but I am all for skipping on new 401k contributions until the debt is paid off.

    People with credit-card debt have no business in investing in the stock market.

  6. Stacey Says:
    March 9th, 2010 at 12:41 am

    @ Evan, 19% is the floor…he has some debt that is at higher rates.

    Any chance he could rollover the plan to the current employer and take a loan? If so that’s the course I would take. I’d also ditch all nonessentials to take care of biz even sooner.

  7. Forex Trader 4 Life Says:
    March 10th, 2010 at 1:34 am

    I would not be advising on liquidating the 401k. But I would suggest stopping on adding on to it further until the credit card situation lightens.

  8. Mel Says:
    March 11th, 2010 at 6:21 pm

    If he’s got an extra $1k to payoff bills, what’s he worried about? $15k may seem like a lot but it’s not. If he said he had $100 instead of $1000 left over than yes, liquidate the 401k. I think we’re all still missing the main point here is that 401k is tax deferred. When it’s time to draw from the 401k down the road, where do you think tax rates will be, lower or higher than today? Take a look at what this administration is doing and you will guess tax rates will be higher, much higher than today! He can bite the bullet now and pay the lower tax rate and the penalty, and it will still be lower than what’s about to come down the road as far as tax rates is concerned. We won’t see these low tax rates for a very long time. His better move is to convert the 401k to a Roth IRA, pay the tax over the next 3 years with the new tax law change and focus on living below his means and eliminate those CC’s.

  9. Rosemarie Says:
    September 23rd, 2010 at 9:41 pm

    What about doing a balance transfer to a new card or another credit card with a lower interest rate? If his credit his good, this would be a way to lower the interest rate and pay the debt off faster.

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