According to the policy group Demos, three-quarters have debt with a median level of $55,3000. And according to the Consumer Federation of America, half of all credit card holders have lingering balances that now average $12,000 to $13,000. A Fidelity Research institute study found that "Among the six out of 10 households that haven't saved for retirement in the past six months, 27 percent were allocating extra funds to pay off credit cards."
When credit card debt continues to accumulate, our survival instincts kick in. Our thought process goes something like this, "I can't stay in debt," 'I need to pay off my debts now," "The most money I have is in my 401(k)," "I'll just use my retirement fund so that I can be debt-free, I can build back up my 401(k) later." It sounds logical, it sounds wide- right? Wrong. This mindset is a recipe for disaster, and this is why:
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•When you withdraw from your 401(k) there is normally a 10% early-withdrawal penalty- and you normally have to pay taxes too
•Your employer will withhold 20% of the amount withdrawn
•Withdrawing from your 401(k) to pay off credit card debt is a dumb idea- because often times the majority of this debt can be wiped out in a bankruptcy filing, without touching your retirement funds
•As USA Today explained- "... say your $10,000 was to grow at an average rate of 6% per year for 35 years. At the end of the 35 years your 401(k) would be work $76,861. So for every $1,000 you withdraw today, you could be costing your future self $7.686."
•Better alternatives would be to lower your credit card rate, lower your home or auto rate, consider a consolidation, drastically reduce expenses, earn extra income, or reduce your retirement plan contributions
According to Money.cnn.com, "Seniors 65 and up carry an average $10,235 on credit cards." What about touching your retirement fund in "extreme cases?" In the words of one financial blogger, "... sometimes drastic situations require drastic measures. If you cannot manage your monthly bills, despite taking a second job, cutting your expenses to the bone and liquidating your non-retirement assets, you can consider going the retirement liquidation route." It is also good to keep in mind that there are exceptions to the early-withdrawal penalty such as if you are 59 ½ or older, are permanently disabled or have used the money for "qualified medical expenses." According to a study by the Ariel Education Initiative, in 2010:
•9% of African-Americans took hardship withdrawals/two-thirds who left their jobs cashed out their 401(k)
•3.2% of Hispanics took hardship withdrawals/57% who left their jobs cashed out their 401(k)
•1.7% of whites took hardship withdrawals/40% who left their jobs cashed out their 401(k)
At the end of 2010, 49% African Americans, 40% of Hispanics and 26% of whites had a 401(k) loan outstanding. A study by the Ariel Education Initiative found that most workers who leave a job with a 401(k) loan outstanding are unable to pay off the balance.
If you are facing a financial crisis and are tempted to dip into your 401(k)- you should consult a bankruptcy attorney first. Leaving your retirement funds intact, getting the majority of your debt dismissed and figuring out a payment plan for the rest could be the best option for you. You can also receive advice about good alternatives to bankruptcy. Regardless, don't rush into a decision that could cause you years of financial strain and regret- it's not worth it.
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