Question:   As part of my debt reduction plans, should I withdraw funds from my 401k to payoff a portion of my debt?

Answer:      Withdrawing funds from an existing 401k is probably not a good idea. In fact, you should consider doing this only as a last resort.

This is especially true for anyone who is truly on the brink of filing bankruptcy or losing their home.

Whatever your particular case may be, searching through all your finances to find potential caches of money may lead you down some dangerous paths.

One of the first things people consider doing to quickly payoff debt is to cash in on their 401k, but the negative impact can be huge. During today’s economy, more and more people are becoming concerned about losing their 401k entirely.

Better to remove it now than let it disappear, right? Wrong.

Withdrawing any amount of funds from your 401k to assist in your debt reduction plans is very seldom a good idea. You will typically lose much more than you will ever hope to gain.

The purpose of the 401k is to provide financial stability during your retirement years, not to be used as a personal line of credit every time you run into financial trouble. Removing funds from this account means substantially less money for you during your retirement years.

When you consider the “future value” of the money you are considering withdrawing today, it’s difficult to make a strong argument for ever withdrawing from your 401k.

Dig a little deeper and you’ll see the costs keep rising!

The money in your 401k is money that has not been taxed. Remember, the money is diverted to your 401k pre-tax so whenever any portion of the balance is withdrawn, you are liable for the taxes on that same amount.

In addition to paying tax, most 401k agreements include an early withdrawal fee, usually around 10%.

In the end, removing money to help with your debt reduction plans will only mean losing a large portion of the money you withdraw from a 401k account. The total cost can amount to over 40% of your principle amount.

If you find yourself facing foreclosure or bankruptcy and have exhausted all other plausible options, crunch the numbers and find out if taking money from your 401k will make any difference.

Generally though, you should leave your 401k alone.

» How does debt affect my employment, and will we ever see a debt free America?
If we lived in a debt free America, there would be no such issue or concern. Most potential employers do require you to sign a waiver that allows them to pull your credit report.

» Does it make sense to use gift credit cards so I earn award points, rebates or mileage?
Various gift credit cards, whether for cash rebates, mileage or points reward programs do not make using credit cards a good thing. The money, mileage or points earned will never be enough to justify the risk that in inherent to playing the credit card game.

» What’s the history of credit cards, and how do I distinguish between good debt and bad debt?
Debt is dumb, it should be avoided at all costs. Just look at the history of credit cards. Less than 50 years ago, it would have been shameful to buy on credit.

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