Search
Advertisement
| Digg | Facebook | Stumble It! | Delicious del.icio.us | Fark
E-mail | Print
May 13, 2008 10:07 am US/Pacific

Using Retirement Savings To Pay Off Consumer Debt

QUESTION:   What are some things I can do to maintain my retirement plan in the face of the economic downturn?
ANSWER:  I would rarely if ever suggest someone take money out of their retirement plan to pay off consumer debt.  If however, you are over the age of 59 1/2 and still working, or retired in or after the year in which you turned 55 and have a 401k or similar plan, I would be open to crunching the numbers.  I would suggest instead looking at the debt that you have, determine the interest rates that apply, and review your cash flow in order to set up a plan that will have the debt paid off
in a relatively short  period of time.  When an individual attacks debt in this way, I think there is a greater appreciation for what it takes to payoff the debt, and is therefore less likely to run the debt back up.  People who take money from retirement plans tend to be serial offenders, and often run the debt back up only to take yet another distribution from their retirement plan.
 
If you really want to see the effect of taking the distribution, your first step would be to add up all your credit card debt, and because the distribution from your retirement account is most likely pretax dollars you would need to pay taxes and penalties on the distribution. The comparison however does not stop there.  You need to then crunch what that money would have been worth at your retirement by growing the distribution until age 65.   This will be an eye opening number.
 
Here is an example:
 
I you have credit card debt equal to $10,000, the amount needed from 401k to pay taxes/penalties and debt $16,666. The distribution amount is arrived at assuming your combined federal and state tax bracket is 27.5%, and a combined penalty of 12.5%.An individual age 40 would not have the $16,666 working for them for the next 25 years.  If, we assume 9% growth on this money, the distribution would have been worth $156,800 at age 65.
 
As you can see what seemed like a relatively small amount of credit card debt, can be quite costly to pay off with retirement funds.
_____________________

Money Matters is provided by:

David Schauer, CFA, MSFA, CFP®
Financial Planner
Hanson McClain
E-mail questions to moneymatters@kovr.com

(© MMVIII, CBS Broadcasting Inc. All Rights Reserved.)

From Our Partners

© MMVIII Sacramento Television Stations Inc. All rights reserved.