Cashing in My 401K to Pay off Credit Cards

Updated on September 13, 2008
J.V. asks from Massapequa, NY
40 answers

Hello All, I have about 8K in credit card debt I would like to pay off. I also have 11K in an old 401K from my previous employer. I know the golden rule is not to cash in the 401K, but would really like to pay off the credit card. I am currently in the 60K, tax braket and would like to know if anyone knows about the pentalties of doing this and if cashing this in would make me get hit twice by taxes, once cashing it in, and then filing my tax return in January? Thanks for any help you can give.

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T.B.

answers from New York on

When you cash it in ask them to take taxes out for you. Just take the $8,000 you need and pay the rest to the government. The penalty is usually 10%. Good Luck to you

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S.H.

answers from Syracuse on

Hi J.,
I am a financial consultant with Primerica. I would love to sit down with you and consider other options. I have to strongly agree with everyone here that it is NOT a good option for so many reasons to touch money set aside for retirment. Please give me a call. I will meet with you for free...
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S. Hansen

C.A.

answers from New York on

DO NOT DO IT! You will get hit so hard in taxes and penalties that you will have to take a loan just to pay that! My mom closed out hers at a previous job and she had to pay back 3k. It's really not worth it. You may want to contact the 401k company and see if you can roll it over into a IRA. Then they won't hit you so hard in penalties. If they won't do it LEAVE IT ALONE!

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R.L.

answers from New York on

Hi J.,
You should consult an accountant to be sure. But, I believe you pay all your capital gains taxes up front. I'd also consult an accountant about the best way to go about paying off the $8K. I'm not saying don't do it. We had to do something similar. However, I was 29 and had a lot of time to build my earnings back up. I had already lost a significant amount of my 401K in the 911 aftermath. Our debt was up around $20k and we were buried each month. So, we had to get drastic to dig ourselves out. By cashing in my 401K, we lopped our debt in half. Anyhow, if I were you I'd seriously consider speaking to an accountant before you do anything. Best of luck!

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K.D.

answers from New York on

DON'T DO IT! Dont cash in your future to pay off the past. You'll be creating more problems. Go to Consumer Credit Counseling Services, of New Jersey or whatever state you're in. I did it and now I'm debt free. They make it easier for you, they negotiate the interest down to 0 in most cases, and negotiate one lump payment for all your credit cards that you can afford and they disperse the payment to the different accounts. The collection calls will stop. It doesn't effect your credit negatively. I paid off 8 or 9 thousand in 3 to 4 years in affordable monthly payments and when I was done with the program my credit score was in the 700s. It's the way to go. Good luck!

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C.D.

answers from New York on

Dont do it. You need a profesion tax guy. When my husband passed used the 401k and lost 1/2 the $ to taxes. Find another way. good luck

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J.P.

answers from Jamestown on

Don't do it! I did it and had to pay huge tax penalties! I am still trying to pay off my income taxes. Have you looked into a home-equity loan? The interest is tax deductible. A low interest consolidation loan would even be better if you do not own a home.

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T.M.

answers from New York on

Hi J., Yep, cashing in your 401K is something I've done. I had about what you have, and with the penalty for cashing it in, I was able to get around $8,000 or so--I don't remember the exact figure. Then, I had to pay taxes on that amount as well. In the long run, it was a smart move for me. I also paid off debt with it.

-T.

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D.Z.

answers from Binghamton on

Hi J.,

I would highly recommend to you a course that my husband and I took this spring...Dave Ramsay's Financial Freedom seminar. If you cannot find the seminar, check out Dave Ramsay's book Total Money Makeover. There is so much amazing information in it.

Please don't cash out your 401K...it is a really bad idea. If something were to happen to you, your little girl will have that 401K...but not if you cash it out...the credit card companies cannot hold your 5 year old responsible for your debt in the event of your death, and they may get it from your 401K, but you'll have it paid off by then anyway!

Don't put your unsecured debt (credit card debt) into a home equity anything...thereby putting your home at risk. Don't make this unsecured debt secured with your home. Another really bad idea.

If you are being harassed by the credit card companies, then you really need to listen to Dave Ramsay's lesson on dealing with creditors. If you email me privately I can tell you more about what he says to do to deal with them. He paints the picture that they (the credit card collectors) are just low paid people sitting at a desk with a headset on, giving you a hard time to try to scare you into paying them. It is so true. They don't have power over your life...but I can tell from your post that it feels to you like you do. You have a responsibility to pay back the debt, but that does not give them the right to harass you. I will tell you much more about this...just let me know if you want to hear it!

D.
[email protected]____.com

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A.S.

answers from Buffalo on

Sounds like you could use some extra income. I am teaching women how to create an entrepreneurial business from their own homes. Let me know if you are interested in learning more about the opportunity.

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A.H.

answers from New York on

You can take a loan on 401 K... it's payable over a long time... and interest is really low. Also call your credit card companies and get lower interest. good luck..

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E.E.

answers from New York on

You should not do it, especially if your APY from the 401K is a higher percentage than the APR on your credit card. You will also probably incur a 10% penalty. On top of that, you will also have to pay the taxes on it and will probably not be left with any money after you pay the taxes and the credit card bill. So you are definitely going to lose a substantial portion of that money. Instead, why not do a rollover IRA? That's what I did when I left my job. This way you will not be paying any taxes on it. I would try calling your credit card company and asking them to lower your APR. As long as you have been paying your bill on time, most credit card companies will do this if you ask. I have called to do this many times and it has always worked for me. Instead, I would suggest when you get your paycheck, set up an automatic deposit with a certain percentage of it going directly into a separate account that you reserve specifically for paying off your credit card each month, that way you will never miss it in your checking account. Be sure to pay more than the minimum each month or you will never pay off the bill. Buy Women & Money by Suze Orman. I love this book and it has lots of good advice about credit cards and other financial questions. Also see if you can talk to a financial adviser about this who can give you advice on your particular situation.
Here is a website I saw that might give you some advice.
http://www.womens-finance.com/401k/cashout.shtml

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R.D.

answers from New York on

ma....don't do it...i learned the hard way, I cashed in mine for about 13k, got stuck paying taxes when they took it out, so all I go was 11k, then they will send you a tax paper, you will then pay taxes again, and then they will penalize you for taking it out b4 you hit like 60 something, so you are like getting hit 3 or 4 times just for that...if you can just take the loan out on it, don't cash it, I wish I would have known what would of happened b4 I took out all of mine, and the income tax that you think you will get back.. don't think about it cuz it won't be none...

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W.K.

answers from New York on

Im not an income tax adviser but have experience in securities. I cashed out my 401K and moved it to another broker so I didnt pay anything on it.. but...what your suggesting is a big no no... the penalties alone would hurt.. you would have to pay 10% no matter what because that is the penalty to cash it in before 59 1/2. Taxes could be 15% - 40%. You could expect to lose half of that 401K to penalties and taxes... sometimes the company holding the 401K will take the taxes out for you but not the penalty. Also keep in mind that cashing in the 11K would increase your annual income from 60K up to 72K which could change your tax bracket.

I had a friend cash out an $80,000 401K... and is paying back about $45,000 in taxes in penalties.

Have you ever looking into Debt Stacking to pay off the Credit Card debt? Its easy to do.

Moving your old 401K into an IRA is something you should also consider - there are a lot of reasons why, research it.

If there is anything I could help you with, feel free to contact me. I can help you out with a debt analysis.

Good Luck

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M.R.

answers from New York on

J. --

I write about financial services for a living. It's not a good idea to do this because you're going to get penalized more than the interest you're paying on the credit cards -- unless you're paying 33% interest. Generally, when you ask for a cash distribution, the plan sponsor will withhold about 1/3rd of the money for the penalty (10%) and the taxes (but they don't always do this and then you'll have to pay it later). Either way, the entire amount will be considered additional income that you earned that year - which could affect your overall tax bracket and you could end up owing more than you think (on all of your income if it pushes you to the next bracket).

If you own a home, I would suggest you get an equity loan or equity line of credit. No matter how high the rate, it's usually lower than your credit cards and the interest payments are tax deductible.

If your debt is spread on different cards and you decide not to cash out your 401(k) or take an equity loan, the best idea is to try to consolidate the debt onto one card if you can. Then you can make a lower payment than the various payments you're making now -- and you'll still pay it off faster.

Hope this was helpful.

M.

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J.H.

answers from Syracuse on

DON'T DO IT!!
Find another way to pay it off...skip buying a coffee in the am, and save that money to put down on your card...I read somewhere that if you are going to pay $100.00 a month on a credit card, it will actually get paid down faster if you make 4 $25.00 payments (one a week).

You'll get there!
Best wishes,
J.

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T.B.

answers from New York on

honey i am no melody hobson or suze orman but here is my 2 cents worth of nonsense.

do not touch the 401k. find a zero apr card and get on a commitment plan to pay a certain amount each month until the 12 month special with this card is over. as you do so, pay on line and always schedule payments. this means when you forget and remmeber to pay the day of, you do not miss the 4 pm deadline and get charged a fee. about 3 months before hte speical is over, find another promotion and do a balance transfer.

if you get paid 2 times a month pay two times. as you pay down this debt, try to avoid anythng that will prevent you from making the monthly amount (NEVER PAY THE MINIMUM always pay more!) or any charge you cannnot pay off in 2 months.

let that 401 k be your nest egg. do not touch it. you can knock that 8K down in 2 years with a commitment plan.

by the way, whatever you do not need, sell it on ebay!!!

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P.M.

answers from New York on

A big NO NO!!! that 11K in 401K will not cover the 8K in debt. After taxes and penalties it will be much less than 8K.

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R.S.

answers from New York on

I just did the same thing recently. There's a 10% penalty for withdrawing and you'll need to list it as income on your taxes at the end of the year. It's not the best way to pay off your credit cards, but I was up to 50K in credit card debt and just didn't see any other way out. Now I'm doubling what I used to contribute to my 401K to play catch up. I hope this helps. Good luck!

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M.T.

answers from New York on

Hi J.,
While it's tempting to do that, the 10% penalty on top of the taxes is really why it's not recommended. You could do better to transfer that credit card balance to a single card with one of those zero percent for a year offers - and then as the year expires, shift it to another such offer. This way, there's just the debt itself and not building interest. Then pay as much over the minimum to reduce the debt as you can. Good luck~

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E.S.

answers from Albany on

DONT do it.

Borrow, to consolidate

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M.F.

answers from New York on

Check with a tax advisor, you can sometimes take a loan against your 401k so you are paying your self back. But you need to check with someone who knows the ins and outs. Do not just take the money because you will be hit twice.

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N.M.

answers from New York on

If you take 8K out of your 401K, you have to pay it back, and it will cost you 12K to pay it back. Not worth it. Pay more than your minimum each month and put all tax return money towards it. AFter that, change your withholding so you are not giving the govt all your moeny, you are getting it in your paycheck not a return. If you check with a tax person you can figure out how little to have them take out without you having to pay, but without you lending the govt your money and then begging them to give it back with your tax return. This will help you to not accumlate debt in the future unless you have something unforeseeable happen.

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D.G.

answers from New York on

Since you are younger than 59 1/2, then you will incur a 10% penalty if you withdraw any funds from your 401(k). That is in addition to the taxes (federal, state, and local) that will be imposed on the withdrawal. Depending on the amount of the withdrawal, you may be pushed into a higher tax bracket than you are currently in (since the withdrawal will be considered as part of your oridinary income). From your post, I guess that you want to take out the entire 401(k) balance?? If so, please consider that given penalties and taxes associated with this, you may just end up with just half that amount to pay off your credit cards, which is not enough to pay off the entire thing. My advice would be to first try to move the credit card balances to lower rate cards (if they are at high interest rates) if you have a good credit score then this will be easy to do. If you cannot move the balances to lower interest cards, and the interest on the cards you have is really high (15%, 20% etc) then consider taking a loan from your 401(k) instead of a withdrawal. With a loan, you avoid the 10% penalty and the money is not taxed unless you fail to pay it back or you lose your job (then it will be considered a withdrawal).

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M.W.

answers from New York on

Don't do it!!! When you initially put the money in - (likely) it came out before your gross income for that pay period was taxed. Now - to pay the money back into your 401k - you not only pay the penalty for early withdrawal, the higher taxes after the withdrawal, but you don't have the option to "pay it back" before tax on your gross income - so, now, you'll get taxed on your gross THEN you put it back in - it's a LOSE, LOSE, LOSE!!! Besides the fact that you will lose all this time gaining money in your 401k - although the economy isn't good right now and it seems like it doesn't matter - it's actually worse to take it out now. B/c, when you put it in - the economy was doing better - now, you have probably lost money somewhere in the accounts, which will get regained when the economy bounces back - but to take it out now means that you have lost the money it made previously and lost out on the option to let it continue to accrue.

Call the credit card companies - tell them that you need the interest rate lowered - if they give you a hard time - tell them that you will call a credit counseling company and set something up which means they will lose even more money than by lowering your interest rates to something reasonable. If you have debt on more than one credit card - try to consolidate them into one.

It really is SO MUCH better to find a way like this to pay it off. If you can save money each week by not buying coffee out - or lunch or something expendable like that - add that to your payment each month. If it is a credit card that charges interest daily - make payments each week if you can, or more than once a month - it lowers the daily principal that gets charged interest and you end up getting charged less. The more you can pay into principal will get you out quickest. Hopefully you aren't using the credit cards anymore or any other line of credit.

Good luck - it is really hard to get out from under this - but you can in other ways that using your 401k. Oh - a word of advice - don't just choose a credit counseling company - some are complete rip off's. If you don't know anyone who has used one that they recommend - let me know. My best friend used one to get out from under debt (then got back into it - so be careful!!!) but I will ask her who it was and get you the name so you know it's a good company.

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C.M.

answers from New York on

I think there are penalties but you need to check your specific plan. I know the feeling about getting clear of your credit card debt. I have borrowed from my retirement account (the same as your 401 K), and pay that back in smaller loan increments. WHy not see if you can hold onto that 401 and find out if you can borrow from it? It'd be much better to have that money growing for you and there for you when you are older and needing it.
I am 44 and the almost sole provider of my soom to be 3 yo little boy too. SO I am keeping in my mind the need for money in the future starting w/ now and balancing our needs today.
If you can't borrow from the 401K, can you cut back anywhere else in your budget to pay back the credit cards or possibly apply for a loan at a smaller interest rate from your bank to consolidate the debts?
Please try to keep your future money there for you and your child's future!

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T.N.

answers from New York on

Hello~

I don't know a ton about this, but I am certain that you are penalized heavily when cashing in a IRA before you are 65. You will pay penalties and taxes on the funds so you can lose well over 30%. I would call your IRA company to confirm but you're right, it's never a good idea. Best bet would be to transfer your credit card balance to a lower interest bearing card. Some cards offer 0% interest on balance transfers for a limited time. Best to look into that option instead.

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B.G.

answers from New York on

I know there is a fee just for cashing it in, not much. Then you can choose to pay the taxes now on the withdrawl or you can wait until January. I believe it is a 10% hit. You still have time to build it back up again if you choose. Go for it!

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R.C.

answers from New York on

J.
Don't do that. You will get penalized for the early withdrawal and you will also pay taxes on that amount. It will be considered ordinary income.

R.

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J.F.

answers from Buffalo on

DON'T DO IT!!! A friend of mine did that to pay off debt and she's kicking herself big time! now that she's in her 50s she really wishes she had saved it all for her retirement. Just pretend its not there... and buckle down to pay off the credit card debt... we owed quite a bit on credit cards... so what i did was transfer it all to a 0% interest card, set a date to have it paid off, figured out how much i'd have to pay each month (it was a several hundred dollars each month, and our income at that time was VERY small - less than 50K yearly total between us) and we just cut waaaaay back on what we spent on everything for the year and a half it took to pay it off. It felt so great to make the last payment and now we're living credit card free (we have 2 cards for emergency use, but haven't touched them). It taught us to live within our means (below our means for a while when we were making those big payments) and we're so much better for it.
I'm don't know too much about financial things beside the basic budgeting, but like someone said, if you have a home, it would probably be wiser to take a line of credit against your equity, the rates would be lower then the credit card and you'll still have your 401K.
You'll be so much happier if you save that 401K for later - you'd get more than if you cashed it out early and you can't take out a loan to fund your retirement like you often can to pay off debt...
good luck :)

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M.P.

answers from New York on

Don't do it. You'll lose about half of it to taxes and penalty fees. Not to mention the future tax-deferred earnings you'll be giving up. Paying off your debt is great, but you could easily get into more debt, and that $11k will be gone. If you keep it earning money, it could grow substantially by the time you retire.

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M.G.

answers from New York on

Hi J.,

Like the other moms, I don't recommend you cash in your 401K. I have a suggestion for you. Do you own a house? If so, you can take out a line of credit against your equity and pay off your bills in one fell swoop. The interest rates are relatively low, and you can make one low monthly payment. You'll also have additional money to use at your discretion. If you don't use it, you don't have to pay on it, but you have the assurance that it's there if you need it. Good luck.

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M.L.

answers from New York on

You have high interest credit card debt. The 401k is not making more that the credit cards are taking. The penalty with 10% off the top when taking it out and then city, state and federal taxes. My financial advisory said to figure about 20%...but that was a few years ago for me so check with a tax person to make sure.
Bottom line..
I cashed out my 401k, talked me credit cards to lower there pay off balances and then started investing again. I have more 5 years later that I had when I did it. I also only have 1 emergency card right now that I use and pay off every month just to keep a good credit history.

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J.C.

answers from New York on

You have really smart women answering your question. I agree. Don't do it. See if you can find a way to lower the interest rates on the credit cards. The banks today are hurting, so I bet you can transfer the money to a no or low interest rate to a different bank.

It's not worth taking that 401K out - save that for the future.

Good Luck!

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K.M.

answers from Syracuse on

I don't have a 401K and don't know anything about them. However, I just paid off $18,000 in credit card debt in about 8 months. I paid as much as I could each month, above the amount due. Plus every single bit of our income tax return went to the credit card. It felt so good to call one of the companys and tell them to cancel my card because it was paid off! Good luck!

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D.D.

answers from New York on

hmmm i would definitely check with your accountant to be safe!

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J.V.

answers from Utica on

What about a regular personal loan from your bank? That way you can choose a payoff period, the balance does not continue to grow, like a credit card balance. Often banks or credit unions will give you a little break on the rate if you are able to do payroll deduction or automatic biweekly payments

Better yet - if you own a home, you could get a home equity loan. That way at least part of your interest would be tax deductable. Cashing in a 401 should always be last resort - remember you can't borrow money to support yourself when you're retired. Good luck!

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D.C.

answers from Binghamton on

I do income taxes for a living so i can answer this for ya! for Federal, you will be taxed the normal tax rate plus a 10% penalty tax. My advice make sure that the extra 10% is with held along with the normal tax rate.

Now for state..some states do not penalize you because you have already paid the tax when it was originally earned, if not that tax will depend on your state. if you would like to e-mail me with what state you live in I can get you that info. my e-mail is: [email protected]____.com.

I hope this helps!

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A.S.

answers from New York on

After paying the withdrawal penalty AND all the taxes on this extra income, which might even bump you into the next tax bracket for your ENTIRE income, you might see practically all of it go to the IRS!! One of my girlfriends had this happen to her. Cashing out her 401K actually ended up putting her deeper into debt and she is really kicking herself now. My husband had almost 20K in debt when I first met him. He got rid of it by talking to the credit card companies and getting them to freeze the accounts, lower the interest rates and work out a payment plan. You must change the way you spend your money, which is something that cashing out your 401K will not teach you to do, either. Credit counseling is an excellent idea, just make sure you find one that DOES NOT take over payments for you, but counsels you on how to manage them yourself.

Good luck!

M.I.

answers from New York on

Dear J.,
Please take the advice of the two previous responders, especially Kathy. I would add two other suggestions: 1)You should make sure that you are getting the LOWEST OR ZERO percent interest on the credit card debts that you do have so that the debt doesn't continue growing while you are paying it down. Call the credit card companies and if they don't lower your interest rate, you must transfer your balance to new cards that give you zero interest. This is easy to do. I am sure you have received credit card offers in the mail for "introductory" rates of 0%. Many of these offers come with checks. You can use one of these checks to pay off your credit cards that are charging you interest and close those accounts. You can also call the new 0% credit card and tell them that you will open this new account with them only if they will extend the introductory 0% rate for one year. Once they have agreed to that (in writing) then pay off the other credit cards (the ones that you have) with the checks from the new 0% credit card. Once you have done that, make a plan (as the other responder suggests) to pay as much as possible every month. You will see that once there is no interest being charged to you, your debt will be reduced so fast. It is also important that you don't use these credit cards any more so that you don't end up in the same position you are now. 2) If by any way you come to some bit of etra money (not by cashing your 401K) you should call the credit card companies to SETTLE your debts. You can do this yourself. Do not hire a debt consolidation company. My husband did this many years ago. He called each company and settled each debt for 50% or less than what he owed. You may be surprised how much they may be willing to negotiate if you call and you stay firm. And whatever you do, please, DO NOT cash in your 401K. Do the rollover IRA and you will be on your way to save for your future. Best of luck!

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