Should We Pull Money From Our 401(k) to Eliminate Our Credit Card Debt?

As someone who cut social media out of my life years ago, I must admit to spending a surprising amount of time on Reddit. In my defense, I initially visited Reddit for an article I was working on and was surprised to find how difficult it was to drag myself away.

I’m fascinated by money-related questions. When someone provides the financial details of their lives, I feel like I’m reading their diary or sticking my nose where it doesn’t belong. Does that inspire me to stop reading? No, it does not. It’s far too enjoyable. For example, this writer asked Reddit readers whether he and his partner should pull money from their 401(k) to eliminate credit card debt.

The details

The writer is 29 years old, and his partner is 28. He says they’re HENRYs – high earners, not rich yet. Here’s his dilemma:

• The couple’s combined income is roughly $400,000, although they expect it to grow significantly over the next two years.
• The original poster has about $100,000 across several retirement accounts, although he didn’t mention how much the partner has saved for retirement.
• They live near a beach in Los Angeles, and though they live in a rent-controlled area, they still pay $5,750 monthly for housing.
• The couple recently self-funded a cross-country move. In addition to covering three months of living expenses without a job, some emergency expenses arose. They used credit cards to pay approximately $35,000 of their costs. Fortunately, they were able to use interest-free credit cards with a 12-month no-interest period.
• The man and his partner didn’t want a lavish wedding and didn’t want financial help from family, so they planned a small local wedding with 20 guests and a $19,000 budget.
• The partner’s firm covered the cost of her graduate school tuition. Though the couple was grateful, they were unclear how this “gift” would work. Shortly after sending out the wedding invitations, the partner’s employer informed her that she must pay taxes on the gift. They’re taking an extra $4,000 monthly out of her paycheck to cover the tax and will continue to do so for two years.
• Because the $4,000 monthly deduction was unexpected, the couple’s budget has gone topsy-turvy. He wants to know if he should pull $20,000 – $40,000 from his retirement accounts to pay the credit card bills and help “ensure we can still have our wedding while my grandparents are alive.”

My take

If one of my sons were asking, my response would be, “Absolutely not. While you may have some compelling reasons to withdraw money from your retirement accounts, it can be a costly mistake.” 

Here are two major drawbacks of taking money from a retirement account:

• Taxes and penalties: Since this man and his partner are nowhere near 59 1/2 , taking funds from retirement will lead to a 10% early withdrawal penalty – and that’s on top of paying ordinary income tax on the funds.
• Missed growth: By withdrawing funds early, the couple misses out on the potential growth of their investments. It’s not as if they can go back in time and recapture those losses.

I know they’re disappointed by the turn of events, but it’s not as if they don’t have options. The original poster seems to be most concerned about paying interest on the credit card debt after the 12-month promotional period expires. While it’s wise to avoid high-interest debt, borrowing from retirement to avoid paying interest doesn’t make much sense in this case. Here’s why:

• I don’t know if the couple is married, but if so, earning $400,000 annually puts them in the 32% tax bracket. Thanks to federal taxes alone, withdrawing $40,000 will cost them $12,000. When you add the 10% penalty for early withdrawal, that’s an additional $4,000.  Withdrawing from his retirement account will cost a whopping $16,000 — not factoring in the potential growth they’re missing out on. 
• Let’s say the 0% promotional period on their card expires, but they’ve been making a minimum monthly payment of $1,000. After 12 months, their credit card debt will be down to $23,000. They have a couple of options. For example, if their credit card carries a “normal” APR of 18%, they can increase their monthly payment from $1,000 to $2,109 and pay the card balances off in one year. If they choose this route, they’ll pay $2,304 in interest. However, since the partner’s firm will continue deducting $4,000 from her checks for another 12 months, they may only feel they can afford to add another $200 to their monthly credit card payments. By increasing their monthly payments from $1,000 to $1,200, the remaining $23,000 will be paid off in less than two years, and they’ll pay $4,362 in interest. Either way, paying off the credit cards without taking money from his retirement account will save them well over $10,000. 

The temptation to take money from an account you don’t expect to need for years or decades can be strong, but the math rarely works out in your favor. If they remain unsure, the couple’s best bet is to meet with a financial advisor who can review the specifics of their situation.

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