Kovar Capital: Using 401(k) Funds to Pay Off Credit Card Debt

By Taylor Kovar

Hi Taylor – I’m 24 and in a bit of a dilemma. I have about $20,000 in my 401(k), but I also have about $16,000 in credit card debt (I know, I know). Would it be a good idea for me to withdraw the money from my 401(k) and pay off this debt? Interest is starting to pile up and I’m afraid it will haunt me forever.

Hey Lisa – I wouldn’t say that’s a good idea. My instinctive reaction is to shout “Nooo!” Taking the penalty on an early withdrawal is a brutal waste of money, but I understand there are many factors at play and different ways of looking at this situation.

A good way to think about this is to consider what will happen next. By taking a massive tax penalty and losing your retirement savings, will you kill your debt, avoid going into debt, and immediately start rebuilding your 401(k)? Or will it be a partial solution that won’t actually solve your problems and will end up being a setback?

If your credit card debt is big enough that you can’t afford the minimum payments and the interest keeps piling up, you need to do something about it. Drawing from a retirement account should always be your last resort; if you can pay off your debt while continuing to save, you will eventually reach a tipping point where debt will decline more quickly and your savings will work for you. Can you cut corners elsewhere? Spend less, exchange your car for a less expensive model, look for a second job? All of these options are better than spending your savings and absorbing a 10% penalty.

More often than not, I think there’s a way to earn or save that you haven’t thought of yet. You may also feel overwhelmed with debt, but making timely payments and putting as much as you can on your credit cards will ease that feeling. It’s easy to watch the money in your retirement account because it sits there unused. But it’s exactly where you want it to be.

If there’s nothing else you can do and you’re headed for collection calls and even tougher times, you can think about tapping into your 401(k). Remember that if you go this route, you have to work even harder to save and avoid falling back into debt. Retirement is a long way off, but the sooner you start saving, the better off you’ll be. Good luck, Lisa!

Disclosure: The information presented is for educational purposes only and does not constitute an offer or solicitation to sell or buy any specific securities, investments or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult a qualified financial advisor and/or tax professional before implementing any strategy described here. To submit a question to be answered in this column, please email it to [email protected], or via USPS to Taylor Kovar, 415 S 1st St, Suite 300, Lufkin, TX 75901.