Personal Finance

Should you use your 401(k) to pay off credit card debt? What the experts say

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Those who’ve been stuck with a credit card balance may wonder if they should use the savings in their 401(k) plan to clear their debt up.

Credit cards, after all, come with high interest rates — the average charge is over 16% a year. Being dinged at that rate, it would take someone with the average household balance of $6,300 more than 17 years to be free of the debt if they were only making the minimum payments.

At the same time, many Americans have most, if not all, of their savings in their 401(k) plans since so many companies automatically enroll their workers in the accounts.

As a result, it may be tempting to use these savings earmarked for decades down the line to get out of debt now.

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There are three ways people could do this: By taking a withdrawal from their 401(k), borrowing from the account or stopping their contributions for a period and redirecting that extra money to their plastic.

In all cases, experts have warnings.

“As much as I dislike credit card debt, it’s hard for me to make a case that you should take an early withdrawal from your 401(k),” said Ted Rossman, industry analyst at CreditCards.com.

That’s because doing so, Rossman said, will cost you.

Withdrawals from 401(k) accounts before age 59½ are subject to a 10% penalty and taxes. That means if you needed $15,000, you’d have to take out close to $24,000, after accounting for those charges, according to Fidelity.

Of course, that cash you pull from the account will also miss out on market gains. Consider that the S&P 500 is up nearly 20% for the year.

All that, Rossman said, “should combine to far outweigh the average credit card rate.”

There may be exceptions. Allan Roth, founder of Wealth Logic in Colorado Springs, Colorado, said that for people over 59½ and in a low tax bracket, a 401(k) withdrawal to pay off credit card debt may make sense because these people are avoiding the 10% penalty and not subject to a huge levy.

“Certainly the math can make it worth it,” Roth said.

For most others, though, there are more appealing options than a withdrawal, Rossman said.

“Stopping your 401(k) contributions for a while — or at least cutting back — and redirecting those funds to debt payoff might make sense,” he said.

Still, that advice comes with an asterisk. If your employer offers a company match, experts recommend you try to at least save up to whatever point that is, be it 3% or 5% of your paychecks.

As much as I dislike credit card debt, it’s hard for me to make a case that you should take an early withdrawal from your 401(k).

Ted Rossman

industry analyst at CreditCards.com

“That’s free money that often doubles your return right there,” Rossman said.

A loan from your 401(k) is also usually preferable to a withdrawal, experts say.

The interest rate on 401(k) loans are typically under 5%, far under the annual charge on most credit cards. The interest paid on the former also goes back into your savings rather than to a bank.

“Using a 401(k) loan to pay off high-interest debt, like credit cards, could reduce the amount you pay in interest to lenders,” said Jessica Macdonald, vice president of thought leadership at Fidelity Investments.

Other benefits to a 401(k) loan, Macdonald said, are that they don’t require a credit check and they don’t show up as debt on your credit report.

But there are things to consider here, too.

For one, you’ll have to be able to repay the loan within five years. You could also face consequences if you leave your job and fail to pay the loan back. In such cases, your loan would be deemed defaulted, and you’d be hit with taxes and that 10% withdrawal penalty on whatever you still owe. And, again, your money will miss out on market returns.

Anyone considering turning to their 401(k) to address credit card balances would also be wise to think about the behavioral reasons why they got into the debt in the first place, which should be explored and addressed.

“If one takes out money to pay off their credit card debt and then buys more to build the debt back up again, it backfired,” Roth said.

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