Should You Pay Off Your Credit Card Debt with a 401k Loan?

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Should you pay off your credit card debt with your 401(k)? The IRS recommends consulting with a financial advisor before taking the steps to withdraw from your retirement savings. If you have credit card debt that you wish to dissolve using your 401(k) savings, read this first.

Should You Use Your 401(k) to Pay Off Credit Card Debt?

It’s no secret that card debt for Americans is on the incline and nearing $1 trillion in the first quarter of 2023. It would be no surprise if you have wondered about your own card debt too, and how you will tackle it. If using your 401(k) has come to mind when answering this question, there are a few factors to consider before taking action with your retirement savings.

What is a 401(k)?

A 401(k) is an employer-sponsored savings plan. It lets you set aside pre-tax dollars from your paycheck to help fund your future retirement. If you have a Roth 401(k), the savings are after-tax dollars. Not all employers offer a 401(k) plan, however, and the ones that do may or may not match a percentage of your salary. According to a Vanguard 2021 report, most plans promise a match between 3.0% and 6.0% of pay. The average value of the promised match was 4.5% of pay, and the median value was 4.0%.

An employer matching any percentage of your salary essentially means free money that goes into a retirement investing account for your benefit. As you can see, a 401(k) plan has the potential to grow exponentially. As a result, you might catch yourself with a nice cushion of savings, which may be tempting enough to use as a means to pay off your credit card debt.

However, doing so will have the long-term effect of putting you at risk later in life when you’re older and perhaps not working as much, or not working at all. During your later years, beyond 62 years of age, you may need to rely on your savings, and retirement savings will make a difference for both everyday and occasional expenses.

The Short-Term Effects of Withdrawing 401(k) Early

Tapping into your retirement savings is only recommended as a last resort. This is not only because of the long-term effects it may have, but also because of the short-term effects. Early withdrawal from your 401(k) may result in penalty fees and taxes.

Borrowers 59½ years old and younger get dealt a 10% withdrawal penalty fee in addition to taxes, which can be anywhere from 20% to 25%, depending on your income and tax bracket. Due to recent stimulus packages, Americans have been able to withdraw from their 401(k) savings penalty-free, but taxes still apply.

According to a Fidelity Investment report, the average 401(k) balance dropped 22.9% in Q3 2022, compared to Q3 2021; 6% from Q2 2022; and a 28% increase from ten years ago. Therefore, withdrawing from a 401(k) does not benefit your future retirement. In addition, taking money out without penalty will also set back your retirement goals.

However, withdrawing without penalty makes more sense for survival reasons like housing or food and is not recommended for non-essentials like credit card debt or loans. It’s best to let the market recover before withdrawing and taking losses on your retirement savings.

Instead of Using Your 401(k) For Credit Card Debt, Do This

Reach out to the card issuer and inquire about available financial hardship plan Participate in a debt management plan through a credit counselor
Apply for a debt consolidation loan Use a balance transfer credit card

The options in the table above can help you tackle credit card debt without depleting or touching your retirement savings. Balance transfer credit cards might seem counterintuitive because it’s basically using a credit card to pay off credit card debt. The benefit of using a balance transfer credit card is that you can transfer your existing card debt to a card with a lower interest rate, which will save you money.

The benefits of a balance transfer credit card depend on responsible use and your credit score. Look for balance transfer cards with lengthy 0% introductory APR offers to avoid paying interest on your debt for some time. This tactic can help you catch up on payments and put more of your repayment money toward your debt versus using some to pay interest. Keep in mind you most likely need to qualify for a higher credit limit when choosing a balance transfer card and should also account for the balance transfer fees (usually between 2% to 5% or a set dollar minimum, whichever is greater.).

And remember, even while paying down credit card debt, you can still maintain your credit score by always making on-time payments. And even if you only have enough to make the minimum payment during financial hardship, you should continue making minimum payments to keep your credit score afloat. On-time payments count for determining 35% of your overall credit score.

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Things To Know About a 401(k) Before Withdrawal

If you’re still considering using your 401(k) to pay down your credit card debt, there are some things you should know about the withdrawal process. There are two ways to take money out of a 401(k) retirement plan:

  • A hardship withdrawal
  • A 401(k) loan

Hardship Withdrawals

Not all 401(k) plans allow hardship withdrawals – this is up to the employer’s discretion. A 401(k) account allows hardship withdrawals for financial needs (as per IRS criteria.), however, credit card debt does not qualify for a hardship withdrawal. You might be eligible for a hardship withdrawal if you:

Have certain medical expenses. Need to pay funeral or burial costs. Purchase a home for the first time.
Have birth or adoption costs (up to $5,000) Incur educational fees that qualify. Must repair your home after a natural disaster
Need to cover payments necessary to prevent eviction or foreclosure on your primary residence.

401(k) Loan

Some 401(k) plans allow loan requests, as long as they abide by IRS guidelines. Through a 401(k) loan you essentially borrow money from yourself (your retirement plan) and then pay yourself back – with interest – within a 5-year repayment period. Usually, 401(k) loans only allow account holders to borrow up to 50% of the vested balance or $50,000, whichever is less. There is an exception, though: If 50% of the vested account balance is less than $10,000, the participant may borrow up to $10,000. However, plans are not required to include the exception.

Another 401(k) loan benefit is that it does not affect your credit, and the interest paid may be tax deductible if individual requirements are met. However, if you leave a job while having an outstanding balance, there will be consequences. Your repayment period may shorten to 60 days to avoid fees and penalties.

The Bottom Line

Although there are certain options for repaying debt through your 401(k), there are other, better alternatives if you need to pay down credit card debt. Ultimately you shouldn’t dip into this account unless it’s an emergency – otherwise, you won’t be doing yourself any favors in the long term.

Related Article: Tips for Choosing a Balance Transfer Credit Card

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About: Jeannyn Gomez
Jeannyn Gomez

Jeannyn is the Content Management Assistant for In addition to serving on all aspects of social media and spreading the word on expert credit and personal finance advice, Jeannyn finds herself on quests for humor, supernatural phenomena, and conspiracy theories for fun.

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