Wisconsin residents overwhelmed by credit card debt often experience harassing phone calls, stress and financial challenges. Most debtors in similar situations want nothing more than to make the stress stop by paying off their high interest credit card debt, but is withdrawing money from a 401K to pay that debt a good idea? Wisconsin residents would be interested to learn that answer is no.
Although withdrawing from a 401K may look like a tempting solution to high interest credit card debt, experts agree that it is not the best solution. Early withdrawal from a 401K plan not only puts the individual in a higher tax bracket, but also results in a 10 percent penalty which can equal as much as a 35 percent tax or more unless there is a showing of hardship. According to the Internal Revenue Service, to qualify for a hardship, one must prove the withdrawal is necessary for “immediate and heavy” expenses. In addition, there is also the cost of not earning interest on the amount that was withdrawn. For example, $15,000 withdrawn from a 401K can earn approximately $60,000 by the time of retirement.
Taking out a loan on the 401K also comes with its own consequences. While a loan avoids the taxes, it does not avoid the interest rate, which will vary according to the terms of each plan. In most cases, the interest rate on the 401K loan is perhaps lower than the interest rate on most high interest credit cards. However, there are other risks involved that should be noted. Generally, the entire loan becomes due if a person leaves the job before the loan is repaid. Additionally, unlike credit card debts where a debtor remains in control of when and how much to pay, debtors lose that control in repaying a 401K loan. Generally repayment on these loans is taken out of each paycheck by the employer each pay period.
While withdrawing or borrowing from a 401K plan to pay high interest credit card debt can stop harassing phone calls and give the debtor peace of mind, it may not be the best solution in the long-run. Other options for eliminating high interest credit card debt may include debt counseling or filing for bankruptcy. Wisconsin debtors can carefully review their options in light of their individual situation with the help of an experienced attorney.
Source: Fox Business, “Withdrawing vs. Borrowing from 401(k) to pay credit card debt” Gary Foreman, April 29, 2013