Should you borrow money from a 401K to pay off a credit card debt? This common problem is one where there isn’t always an easy answer, but we can break down the problem to see which solution is best for you.
First, know that in almost every circumstance a credit card interest rate will be higher than the returns you can expect from stocks or bonds. So, in general, the return you get from paying down debt is higher than having money invested for retirement.
On the other hand, there are a few restrictions to 401K loans that are not conducive to repaying a credit card debt:
- Losing your job – If you lose your job, the 401k loan will have to be repaid immediately. If the loan is not repaid within 60 days, you will have to pay a 10% penalty to the IRS alongside taxes on the money that you took from the 401k as a loan. This may make a 401k loan more costly than other options already.
- Psychological – Credit card debt usually comes from a spending problem. Bailing out a credit card debt with a 401K loan only makes it easier to keep spending money on your credit card. Making an earnest effort to repay a debt without using your credit cards will remind you how important it is to live within a budget.
All in, the best answer as far as numbers go is to use a 401K loan to repay your credit card debt. Credit cards cost more than the stock market will give you over time. However, it does not get to the root of the problem which is that you might just be spending too much on your credit cards in the first place. If you feel secure in your job and your ability to repay your credit card loan, then by all means, consider a 401K loan. If not, make the effort to really work hard and pay down the balance by cutting from other parts of your budget, not your retirement account.