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  #1  
Old 06-06-2007, 05:52 PM
Wayne36 Wayne36 is offline
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Default Cash out 401K to pay off debt?

Hey everyone,
My wife and I have 2 credit cards with a balance of $17,000 and her school loan with a balance of $25,000. We have a very low mortage payment of $490 and only one car payment of $189. We have made extra effort to cut out all luxuries until the debt is paid off. We were making progress. But now we have a baby coming and, although it is a blessing, it makes matters more difficult. I really can't find anywhere else to cut. We've cut cell phones, cable tv, eating out (mostly), etc.
I have 35K in my 401k account. should I take the penalty and use it? what other options do I have?
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  #2  
Old 06-06-2007, 07:29 PM
Mark A Mark A is offline
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Default Re: Cash out 401K to pay off debt?

Why are the credit card balances so high? The minimum payments on those must be a real challenge to make. You may want to consider a Home Equity Line of Credit just to pay those cards off, or if one is lower pay that one off fast.

Dru or Chris would do a great job of explaining about your 401k and the benefits/problems with cashing it out early.
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Old 06-07-2007, 01:40 AM
sturob sturob is offline
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Default Re: Cash out 401K to pay off debt?

While it's a last resort, you may be best off getting a 401k loan. Assuming you are currently employed where you have the $35K, most employers allow you take a 401k loan. You then pay yourself back, including interest of the loan, into your 401k. Couple things to be aware of: 1) the money taken out for a loan will not earn any returns -- hurting your nest egg's growth; 2) if your job is not secure or you plan to switch employers soon, do not go this way. If you lose your job or go to a new employer, the loan becomes due when you leave. If you can not pay the loan back at this time, the outstanding part of the loan will be hit with full taxes including the 10% additional penalty for early withdrawal.

The limit for a 401k loan is up to $50K. As you have less than this, you may be required to keep a certain amount in your 401k. You may have to pay a small fee to process the loan -- typically less than 100.
Good luck.

Last edited by sturob; 06-07-2007 at 01:45 AM. Reason: Hadn't finished my comment
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Old 06-08-2007, 07:14 PM
tater03 tater03 is offline
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Default Re: Cash out 401K to pay off debt?

Yes, I would definently get the loan if yours is set up that way. The taxes are atrocious if you just take or close out an account.
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Old 06-08-2007, 10:57 PM
Dru Dru is offline
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Default Re: Cash out 401K to pay off debt?

There is some missing information here. Do you both work? Will that be changing? What is your annual income? What is the home worth? Do you have access to other assets? Do you have insurance that covers the birth expenses?

It sounds to me like you have made a beginning to look at expenses, but now you are looking for an easy fix. This easy fix comes at the expense of lost interest income potential, possible tax and penalty consequences, future repayment obligations and more. You are robbing from yourself the future value you are giving up.

Look at some of the questions I have poised. What other options do you have? Is it really so desperate or could you continue to "pay as you go". True, you may not be in a position to contribute additional funds to the 401K, but pulling from it is a serious consideration.

Are you a good customer of the credit cards? If you have been on time with payments, you may find that a call to them could reduce your interest rates. Let them know you plan to move the debt elsewhere and close the account. They may find you are worth keeping around.

School loans are probably at a low interest rate. You don't want to mess with those unless it puts you into a better situation. You have buried yourself with the CC's (don't fret, you're not alone) by living beyond your means. This is all too common a story in todays society. The answer is to cut them in half and stick them in a drawer as you work to pay down the balance. Stop spending money you do not have. My wife used to tell me she found some things on sale, so she bought them with her credit card. At 10% or 15% or 20% and minimum payments, those items cost way more than the savings she thought she was capturing. As we all scream at the gas pumps when we pay $50 to fill a tank, does it make sense to add an additional 5-10 or $15? Yet that is what could happen if you made a minimum payment on that charge.

You are going to have to get tough on yourselves for a while. Dave Ramsey says, "eat rice and beans for the next two years". And he means it literally. Also look at the fact you are young and have lots of energy. Can you work more hours at your job, or get a second job to focus on paying off the debts? Your mortgage is nice and low, but what if you could rent it out for a couple of years while you move in with family? This may even produce some positive cash above the mortgage expense that could be put toward debt. Look hard, then be smart before you give up your future.
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Old 06-10-2007, 07:32 PM
tater03 tater03 is offline
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Default Re: Cash out 401K to pay off debt?

I know that my husband took a second job in the evening for theree days a week when I was on maternity leave to help with the bills. That is a good option if you can find something like that.
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Old 06-10-2007, 11:51 PM
Mynion Mynion is offline
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Default Re: Cash out 401K to pay off debt?

I agree with Dru, it's tough to diagnose the situation without factoring in all possibilities.

Generally, the 401k loan would be the worst way to go. (You are accepting double-taxation in exchange for avoiding the 10% penalty... ugh!)

The student loan is likely at a good rate and you may be getting a tax deducation on some of the interest. This is best left alone and should be one of the last items you pay off. Some student loans will also reduce their rate if you do automatic payment plans, etc.

A 2nd job is a fabulous way to increase your cash flow over a period of time. This is what I did several years back to pay off our credit card debt, and I'm proud to say we currently have none. Once the debt was paid off, I quit.

The mortgage payment is great and you can't even get a good apartment for that amount (at least not in my area!). Renting your home out is an option but it's likely that you'll need the extra space with a baby on the way. Also, it seems like you don't have any experience being a landlord, which has its own challenges.

Negotiating with your creditor is a good move to lower those interest rates. A fixed-rate home equity line of credit may also be good if you have sufficient equity in the home to cover the credit card debt. For others reading, *do not* move credit card debt to a home equity line if job security or cash flow is an issue. While it improves cash flow, you are moving unsecured debt to secured debt, which if you have to file bankruptcy is a huge difference (unsecured debt goes bye-bye, secured gets restructured).

What you are doing with your budget is great! Keep it up! Anytime you have an expense, ask yourself "Do I really need this?" Also, don't make any purchases over $100 (aside from groceries) while you are at the store. Take your time, shop around, and think about it overnight. This will suppress some bad urges and help you think clearly.

First thing I would do is stop contributing to my 401k, and take that money and use it to pay down the credit cards first. If you are undisciplined, then you have to be careful that you turn everything back on once you've paid off the debt. What about matching contributions? In the long run you'll save more in interest than you get in the match.

Lastly, if you have to, it makes NO SENSE to keep money in your 401k, even earning a 10% rate of return (which many would die for), if you are paying 25+% in interest charges for the credit cards. Take out what you need (make sure to gross up the amount by 20% for tax-withholding and 10% penalty), pay off the credit cards, and then commit yourself to not ever getting in this situation again. You won't have to pay the penalty and the tax difference (withholding vs. actual) until you file your taxes.
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Old 06-10-2007, 11:57 PM
Mynion Mynion is offline
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Default Re: Cash out 401K to pay off debt?

By the way, read about financial hardship with your 401k. It is one of the select loopholes in 401k plans that allows you to get money out under certain circumstances without having to pay a 10% penalty. Once such circumstance is financial hardship. Each plan is different so you need to talk to your plan administrator. The mandatory withholding (20%) will still apply.

Chris
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