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.