But if you’re thinking about taking money out of your 401(k) to cover an expense or pay off debt, ask yourself this: Do I really want to borrow money at 30% interest? Learn why a Roth IRA may be a better choice than a traditional IRA for some retirement savers. You also have to pay taxes on whatever you take out, but the IRS usually withholds 20% automatically. List your outstanding credit card debts, from highest interest to lowest. The money is used to pay an IRS levy (a legal taking of property to pay back a tax debt). Any part of the withdrawal that comes from investment earnings is subject to taxes if you take it out before the age of 59½. When that snowball starts rolling, it’ll give you the momentum you need to get out of debt for good! [See: 9 Easy Ways to Save $500 More Per Year for … Other methods for paying off debt include: It’s important to examine other options to make sure the path you are on is the right one for you. The money is used to pay medical expenses (as long as those expenses add up to more than 10% of your gross income). This is to protect you from doing exactly what you are planning to do right now: withdrawing money early and not having enough money left over for your retirement. "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.". 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. Even if you qualify for an exemption from the penalty, the regular income taxes on your withdrawal are still due. Determine how much debt you want to pay off using your IRA. 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. Whether you pronounce it eye-ruh or you sound out each letter, an IRA (Individual Retirement Account) is a great tool to build wealth and make sure you retire with dignity. A Roth IRA allows you to withdraw funds tax-free, assuming the money has been there at least five years, because that contribution was made with after-tax dollars. Kick off your money reset with our FREE livestream! Okay, so … Don't do it. A number of apps and online spreadsheets promote a variety of debt reduction strategies such as paying the cards with the highest interest rates first, or the debt snowball method. Depending on the type of account you have, the rules may vary when it comes to withdrawals. Definitely, do not use your IRA funds to pay off your mortgage. After all, it's meant to be tucked away until you retire, and isn't a cash machine. The money is used for qualified higher education expenses (college tuition, room and board, books, etc.). Accessed April 28, 2020. It’s not money for today; it’s money for tomorrow. Like a 401(k), there are some exceptions to the early withdrawal penalty for traditional IRAs (We’ll dive into those in a minute.). Congratulations. How Financial Advisors Can Help With Debt, The 7 Best Debt Reduction Software Programs of 2020, Retirement Topics - Exceptions to Tax on Early Distributions. But the key word here is retire. Investopedia requires writers to use primary sources to support their work. 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! If you wish to proceed, it’s important to follow a plan that minimizes collateral financial damage. Many people say they can make up for the loss by putting more money in their IRA later, but there are limits to how much you can contribute each year. Training, Executive You should also consider making cuts wherever possible. Retirement. Ramsey+, Do This First If You Want to Get Out of Debt. 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. When calculating how much to withdraw, take into account any taxes and penalties, along with the amount of debt you wish to pay off. Unlike other options like a debt consolidation loan, you don’t have to make any repayments with … A full list of exceptions appears on this IRS chart. You could end up paying about $5,000 in penalties and around another $15,000 in taxes—leaving you with only $30,000. First of all, it’s important to acknowledge up front that this may not be a wise financial move for several reasons. Consider using … 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 … Why Adam Might Want to Invest While Paying Off Debt… If Adam sticks with his plan to put his entire surplus toward paying off his debt rather than investing, he’ll make 24 payments of about $2,226 and pay just over $3,400 in interest. The government does not want you to withdraw money from your retirement accounts until you reach age 59 ½. "Paying off credit card debt using your IRA jeopardizes your future retirement savings," says Carolyn Howard, founder of SeaCure Advisors LLC, in Sarasota, Fla. "It also causes you to pay more for the credit card debt due to the taxes on the IRA withdrawal.". Learn But too many people treat their retirement fund as their emergency fund. Using Your IRA to Pay off Credit Card Debt The Downside. And a budgeting tool like EveryDollar forces you to be more intentional with the money you have now, instead of wondering where it went later. It’s never too late to change your money habits and set yourself up for a successful future! "One of the benefits of a retirement account is the tax-deferred or tax-free growth of your principal. Get out of debt quicker. But you're not out of the woods yet. We’re glad you asked! You can potentially pay off all your debt at once if you have enough funds in your IRA. So if you don’t cash out your retirement fund, how do you pay off your debt? Remember that the rules for traditional and Roth accounts are different. But you’re not alone. "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.". If you have a Roth account, the taxes have already been paid, so skip this step. You cannot effectively replace withdrawn funds since there are limits on the amount you can contribute to your IRA in any given year. When you withdraw money early from your 401 (k) or IRA, you’ll be required to pay taxes. You’ll learn all you need to know about paying off debt, saving money, and investing wisely so you can build wealth and be on your way to everyday millionaire status. If you could find a way to only withdraw your $6,000 in contributions you wouldn’t pay any tax or penalty. Before making any withdrawals, make sure you consider other options for paying off your credit card debt. Sure, those funds are supposed to stay untouched until you retire. This consists of taking a hard look at how much money comes in, how much goes out. If you do not need to withdraw the full amount, make sure you're allowed partial withdrawals. 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. This is a losing proposition. A Roth IRA is a retirement savings account that allows you to withdraw your money tax-free. A reader name Sam recently wrote in to ask about using Roth IRA funds to pay off debt.Here’s his question: I have around $19, 500 in a Vanguard Roth IRA. Otherwise, you must pay the 10% early withdrawal fee, plus any taxes. But even if you can take money out of your IRA, it doesn’t mean you should. This means that more money is working for you to grow your retirement nest egg. We have about $40k in debt … 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. There’s also an exception to the early withdrawal penalty for a 401(k) if you receive a “hardship distribution.” This is money taken out of your 401(k) to meet an “immediate and heavy financial need,” according to the IRS, and could include things like repairing damage to your home after a natural disaster, covering funeral expenses for a loved one, or paying rent to avoid eviction. 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. Dave Ramsey says you shouldn’t take money out of your IRA early unless it’s to avoid bankruptcy or foreclosure. 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. Don’t make the mistake of assuming you can invest the IRA in stocks and earn a lot more than 1%. Sometimes it just takes doing the math to realize what you’d actually lose. "Retirement Topics - Exceptions to Tax on Early Distributions." If your financial planner suggested this course of action, you may want to look for a new one. A Ramsey Solutions Master Financial Coach can encourage you and help you make the best decision for your financial situation. The money is used to cover health insurance premiums if you’re unemployed. The first step toward becoming smarter with your money might surprise you. Unfortunately, this is almost always a really bad idea. Withdrawing money from a 401(k) early comes with a 10% penalty. The 5-year rule deals with withdrawals from Roth and traditional IRAs. Debt. 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. 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. Read on to find out more about the downsides to using your retirement funds to pay off your credit card debt. Any withdrawals from a traditional IRA before the age of 59½ are subject to taxes and a 10% penalty. Use our investment calculator to see what your IRA will be worth when it’s time for you to retire. Start by listing all outstanding credit card debt, in order of annual percentage rate (APR), from highest to lowest. It may be tempting to scrape a little off the top for a big-ticket item you couldn't otherwise afford, or to use it for a quick, unexpected vacation. the But the truth is, you can’t borrow your way out of debt, so you should avoid loans altogether. 11 Minute Read Keep a handle on your spending and credit card use. And that’s if you don’t contribute anything on top of that. Here are some tried and true methods for knocking out debt that your future self won’t regret. Because of this, the IRS charges penalties for most types of early withdrawals. Yuck! Make sure you use the funds to pay off your debt, and use wise financial decisions so you don't end up overwhelmed by debt again. 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. There are different ways to attack 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. More specifically, using your retirement to pay down debt. Taking control of your money starts with having a written plan—a budget. If you had $10,000 in debt to pay off you would need to come up with an additional $1,400 to pay it off. Local Provider, Free Trial of Here's another consideration that you may need to consider. 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