When you are overwhelmed by bills you can’t handle, it is important to consider all of the options you have available to pay them off. That’s why many people overburdened by debt find themselves asking, “Should I use my 401k to pay off debt?” As Cleveland bankruptcy attorneys, we hear this question all the time. While it’s not easy to give a clear-cut answer that will apply to every situation, financial advisors generally agree that it’s a bad idea to dip into your 401k for debt repayment.
Although a 401k is often the largest chunk of savings that most Americans have access to, it’s savings that are intended for retirement, not short-term needs. When you are struggling to pay off serious debts, borrowing from your 401k may seem like a great solution, but in reality the immediate benefit may not outweigh the long-term costs.
Why Borrowing from Your 401k to Pay Off Debt May Not Be in Your Best Interests
In order to help illustrate this better, the following are five reasons why borrowing from your 401k to pay off debt may not be in your best interests.
1. The numbers almost never work in your favor. If you do the math, it almost always tells the same clear story — you will lose more money by taking money out of your 401k than you gain by paying off your short-term debts. When you cash out or borrow from your 401k, there are financial penalties. You have to pay taxes on the money you receive, and you have to pay a penalty for early withdrawal. So you don’t get the actual amount of money that you had saved. In fact, you may receive significantly less. If you can handle your debt payments or can find another alternative to deal with the debt, it may be best to leave your 401k alone.
2. The opportunity cost is great. Not only do you pay penalties on your 401k when using it to pay off debt, you also miss out on potential payoffs in the future through growth from 401k investments. In addition, you’re paying the debt with after-tax money, defeating the purpose of the pre-tax 401k savings.
3. Time will be working against you when it comes to saving for retirement. Since you are taking money out of your 401k, there will be less principle there to earn interest over the long-term. This can do real damage to your retirement plans. While it’s tempting to see retirement as something far off in the future, the reality is that retirement comes sooner than you expect — and many people find they’re not adequately prepared financially. If you take money out of your retirement fund now, you may regret it later on.
4. There are serious risks if you lose your job (or even just want to change jobs). If you lose your job, you won’t have the 401k to lean on in hardship. For many people, this makes the risk too great unless you have a very stable job. If you are actually borrowing from your 401k, it’s an even greater risk. If you leave your job or get laid off, you usually must pay back your 401k loan in full within 60 days, which few people using it for debt reasons will be able to do.
5. You may be simply financing poor financial habits. In many cases, using a 401k to pay off debts is simply indicative of a greater problem. If you are living beyond your means or financing a lifestyle that you cannot really afford, you’ll only run into the same problem later — only this time without your 401k savings to fall back on.
As you can see, using a 401k to pay off debts can present a serious risk to your long-term financial future. We recommend not considering this option except as a last resort when all other options have been exhausted. Before cashing out or borrowing from your 401k, we recommend talking to an Ohio debt help lawyer about your situation. You may find that more beneficial solutions to your debt problems are available.
If you are drowning in debt and looking for a solution, call the Cleveland bankruptcy attorneys at Luftman, Heck & Associates for a free consultation today at (216) 586-6600. We will be happy to explain your option and help you decide which one is right for you.