So if you don’t cash out your retirement fund, how do you pay off your debt? While you still have to pay taxes on any money taken out of a 401(k) or IRA before a certain age, there are some circumstances that would let you get around the 10% early withdrawal penalty for retirement funds. Now, Be a Part of That’s not okay! If you still feel like borrowing from your retirement fund is your only hope, you might just need someone to talk you through your options. You will then use that money you save on the eliminated account to pay off the next lowest balance card, and so on, until your entire debt load is clear. This basically means you have to continually take out a certain amount from your retirement fund over time—and that’s determined by your account balance and life expectancy. So, if you took $20,000 from your 401(k) and that puts you in the 22% tax bracket, you may only get about $12,000–13,000 (depending on state income tax) when all is said and done. And that’s if you don’t contribute anything on top of that. You just apply bigger amounts to each remaining balance until all accounts are at zero. But the truth is, you can’t borrow your way out of debt, so you should avoid loans altogether. When calculating how much to withdraw, take into account any taxes and penalties, along with the amount of debt you wish to pay off. Yuck! Get out of debt quicker. If you’re in the middle of paying off your credit cards, car loans or student loans, you know that every extra dollar toward debt helps. Still, sometimes using an IRA to pay off consumer debt is the best available option. [See: 9 Easy Ways to Save $500 More Per Year for … Read on to find out more about the downsides to using your retirement funds to pay off your credit card debt. But the key word here is retire. Another mistake people make is taking out a 401(k) loan to pay off their debt—but you end up having to pay yourself back with interest. You can potentially pay off all your debt at once if you have enough funds in your IRA. It can be very tempting for debtors to tap into their IRA to pay off debt, but it comes at a hefty price. We know you work hard, and the last thing you want is to have to work harder and longer because you didn’t save enough for retirement. You may be tempted to just pull the money out of your 401(k) or IRA to pay back your creditors and kiss your debt goodbye for good. In addition, if you're making that withdrawal before the age of 59½, you will owe a 10% tax penalty. Calculate whether the total amount you wish to withdraw will put you in a higher tax bracket. A traditional IRA (individual retirement account) allows individuals to direct pre-tax income toward investments that can grow tax-deferred. "Because credit card debt has such high interest rates, there are virtually no investments that will outperform it," says Cullen Breen, president of Dutch Asset Corporation in Albany, N.Y. "Because of this it can make sense to take the money from elsewhere.". Withdrawing funds from your IRA is not a wise financial decision. Start by listing all outstanding credit card debt, in order of annual percentage rate (APR), from highest to lowest. But you're not out of the woods yet. Because using your retirement fund for anything other than retirement can come at a big cost. Also, keep in mind that nontaxable rollovers can only be done once every 12 months. ©2021 Lampo Licensing, LLC. Before making any withdrawals, make sure you consider other options for paying off your credit card debt. The 401(k) is divided in a divorce under what’s known as a Qualified Domestic Relations Order. You’re in it for the long haul, and investing takes a decent amount of patience and self-control. Roth IRAs limit withdrawal amounts—which are also taxed—and funds must be in the account for at least five years. Since a Roth IRA uses after-tax dollars but grows tax-free (one of the reasons why we love it so much), you’re able to pull out any of your contributions, regardless of your age and without penalties or taxes. This strategy involves paying off the account with the lowest balance first, while making minimum payments on the rest. Sometimes it just takes doing the math to realize what you’d actually lose. Once the funds are in your checking account, promptly pay off the credit cards you earmarked in order of highest APR. When you’ve got mountains of debt staring you in the face, it’s hard not to worry. Ramsey+, Do This First If You Want to Get Out of Debt. With a traditional IRA, since you did not pay taxes on the money before you put it in, you have to pay income taxes when you take it out. When you withdraw money early from your 401 (k) or IRA, you’ll be required to pay taxes. The 5-year rule deals with withdrawals from Roth and traditional IRAs. A full list of early withdrawal penalty exceptions is available on the IRS website. But suppose Adam opts to use part of his surplus to max out his Roth IRA … We also reference original research from other reputable publishers where appropriate. When your IRA becomes an ATM, you lose out on all the money you would have earned with compound interest. These include white papers, government data, original reporting, and interviews with industry experts. Because using your retirement fund for anything other than retirement can come at a big cost. Use the money for the intended purpose and for nothing else. It’s never too late to change your money habits and set yourself up for a successful future! First, you should understand the rules. We’ve broken down what happens when you cash out a retirement fund early, and we’ll tell you how you can pay off debt without raiding your IRA. And the penalties and taxes you have to pay on that money depend on the type of retirement account it came from: 401(k), traditional IRA or Roth IRA. There’s no automatic withholding, but you still have to pay federal and state income tax on the amount you took out when it’s time to file your taxes. If it’s your best available option, make sure you are well-organized and prepared to avoid traps. Here’s everything you need to know about Roth IRAs. File Your Own? Why? In response to my recent post about Roth IRA withdrawal penalties, a reader named Aaron asked the following:. Once the smallest debt is gone, take that payment and apply it to the next-smallest debt. The money is used to pay an IRS levy (a legal taking of property to pay back a tax debt). A significant early withdrawal of traditional IRA funds could bump you into a higher tax bracket. There are different ways to attack your debt. Why? Dave Ramseysays you shouldn’t take money out of your IRA early unless it’s to avoid bankruptcy or foreclosure. Any part of the withdrawal that comes from investment earnings is subject to taxes if you take it out before the age of 59½. You Should Pay off These Types of Debts First, When Paying off Debt With Your 401(k) Makes Sense, Using Your IRA to Pay Off Credit Card Debt. How Financial Advisors Can Help With Debt, The 7 Best Debt Reduction Software Programs of 2020, Retirement Topics - Exceptions to Tax on Early Distributions. and Syndication, Get the Ramsey Network Training, Executive Show, Advertising Like a 401(k), there are some exceptions to the early withdrawal penalty for traditional IRAs (We’ll dive into those in a minute.). It’s like Chris Hogan says: “Compound interest is your best friend, but only when you give it the opportunity to work.” That’s what we call free money to those who wait. And you’re only allowed to take out the exact amount needed for these expenses. If you really want to make sure your retirement dreams become a reality, start a free trial of Ramsey+ and take control of your finances! After all this, you've decided to make that withdrawal, you've prepared yourself for the implications, and you pay off your debt. You feel like you're drowning in credit card debt. It’s not money for today; it’s money for tomorrow. If you’re at that point where you want to do anything to get out of debt, you might consider selling your investments. Withdrawing funds from an IRA before age of 59½ will result in a 10% penalty. Use our investment calculator to see what your IRA will be worth when it’s time for you to retire. Unfortunately, this is almost always a really bad idea. Regardless of what strategy you use, they involve applying the same amount of money to reduce debt each month—even after one account is paid off. You've got debt you want to pay off, and you need to save for retirement, too. Withdrawing money from a 401(k) early comes with a 10% penalty. A withdrawal penalty is a penalty or extra charge incurred by an individual from an account where withdrawals are controlled according to a timeline. Debt. "It's wise to be as tax-conscious as possible," says Carlos Dias Jr., founder and managing partner of Dias Wealth LLC in Lake Mary, Fla. "I always recommend running a projection report with an accountant or software (if you know what to do), potentially spreading the tax liability over several years.". While it may be tempting, taking money out of an IRA to pay off debt is a terrible idea. Howard Dvorkin, CPA and Debt.com chairman responds… Without studying your Roth IRA in detail, I can’t advise you for certain – but you probably shouldn’t raid your IRA to pay off your student … Of course not! Should he just pay it off with interest or take some money out of the Roth to pay it off? Debt Avalanche vs. Debt Snowball: What's the Difference? As good as it is to get out of debt, using IRA funds to do so comes at a cost, and not just the immediate ones of the taxes and penalties. "Retirement Topics - Exceptions to Tax on Early Distributions." Money taken … The idea is that you gain momentum along the way, much like a snowball rolling down a hill, and eventually pay off the largest debt. You should also consider making cuts wherever possible. If you have money in an individual retirement account (IRA), you can withdraw funds to pay off credit card debt and potentially save yourself thousands of dollars in interest. Otherwise, the government will take its cut in the form of penalties and taxes. So be careful about what you call an emergency and save your 401(k) for later. Here's another consideration that you may need to consider. The money is used toward the purchase or building of a first home (up to $10,000). Giving every dollar a job to do also helps you build a solid emergency fund so you won’t be tempted to tap into your IRA when life throws you a curveball. How to Pay Off Debt and Save for Retirement When you ask for advice on whether you should pay off debt or save for retirement first, you’ll quickly encounter the crowd that thinks all debt is … Local Provider, Free Trial of Learn Using Your IRA to Pay off Credit Card Debt The Downside. This means you may need to drop satellite or cable for over-the-air television, carpooling instead of driving to work, or borrowing books from the library instead of buying them from Amazon. A full list of exceptions appears on this IRS chart. The same would apply to earnings from a Roth IRA, which would be taxed and considered income in the year in which it was withdrawn. A Roth IRA is a retirement savings account that allows you to withdraw your money tax-free. Otherwise, you must pay the 10% early withdrawal fee, plus any taxes. But the key word here is retire. Dave Ramsey says you shouldn’t take money out of your IRA early unless it’s to avoid bankruptcy or foreclosure. 11 Minute Read When you withdraw funds early from an IRA, you will likely face taxes and/or penalties, which can add substantially to the cost of taking out that money. After all, it’s your hard-earned money, and you deserve to hold onto as much of it as possible. Any withdrawals from a traditional IRA before the age of 59½ are subject to taxes and a 10% penalty. Consider using … No repayments. Definitely, do not use your IRA funds to pay off your mortgage. Don’t make the mistake of assuming you can invest the IRA in stocks and earn a lot more than 1%. A: Yes, you can withdraw money from your Roth IRA to pay off debt. First of all, it’s important to acknowledge up front that this may not be a wise financial move for... Making the Withdrawal. Support their work government will take its cut in the military and are called to duty. 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