401k vs credit card debt

Hazmat54 · #1 04/10/11, 01:32 PM

I am 57 yrs old and wanting to get finances in order before retirement. I have credit card debt, and 401k money I can borrow. I don't want to withdraw money from the 401k and pay the penalty. I can borrow enough from the 401k to pay off the CC's. The 401k repayment deduction from my paycheck will be less than my current CC payments. That is by setting up the payments over 3 years, which is the earliest I might think of retiring. The 401k loan will be a much lower interest. Well actually I will be paying it back to myself.

The question is, is this a good idea? It seems to me a no brainer good idea. But is there something I am overlooking? It will not be the entire amount I can borrow from the 401k. Meaning there will be some available if some emergency comes up, without having to make a penalty withdrawal.

Any gotcha's to worry about?

Scott

Pink_Carnation · #2 04/10/11, 02:14 PM

What happens if you lose your job? The other thing is have you stopped adding to the credit cards?

where I want to · #3 04/10/11, 02:19 PM

You will have paid income tax on the money you use to repay the loan. I don't think there is any tax exemption for repaying a loan to a 401k as there is for contributions. I don't think that the actual loan money is taxable unless you do not repay it. And you will pay income tax again when you finally take it out at retirement.
And the credit card can be easily charged up again.

wwubben · #4 04/10/11, 07:47 PM

Do not even think of touching your 401K.

Explorer · #5 04/10/11, 07:53 PM

How long have you carried debt on your credit card? (Is it a habit you need to break.)

Beeman · #6 04/10/11, 08:12 PM

If you buckeled down how fast could you pay off the CC without touching the 401k? What if you reduced your input to the 401K and applied it to the cc?

haypoint · #7 04/10/11, 08:33 PM

When I started reading this, I thought you were going to withdraw from your 401K and pay the penalty just to get the CC dept off your back. When I read that you could borrow from your 401K, at a lower interest rate, I was thinking that would be a good way to save a few percentages of interest.

But, then the fact that you'll be paying the loan with after tax income, I thought, "Hold on a minute."
If you are currently paying income taxes at a higher percentage than you will when you retire, you should wait and pay the CC debt off with the lower taxed 401K money. That means you should add more to your 401K now, like the money you were going to pay off the 401K loan with.

But, if you are slumming with the rest of us, paying taxes at the same rate now as you will be upon retirement, you might as well borrow against the 401K and get the higher interest off your back.

If you reduced your contrabution to your 401K and put more toward paying off the CC, you'd still be paying the higher CC interest and with less of your income going to the 401K, you'll pay more federal, state taxes and SS and Medicare deductions on your larger taxable wage.

Fat Charlie · #8 04/10/11, 09:35 PM

Taking a loan from your 401k is the right move. You'll be paying a lower interest rate on the debt, and you'll be paying that interest to yourself anyway. Income tax on the loan repayment money is irrelevant- you've paid income tax on the money you're mailing to the CC company too.

Forest · #9 04/10/11, 09:44 PM

I don't know what your 401(k) is invested in, but make sure that you include the lost investment gain in your calculations. If you loose a return of say 8 % on the money that you need to borrow, that's a very expensive loan you are taking out. Also don't forget the compound interest.

switchman62 · #10 04/10/11, 10:10 PM

There have been several good points stated above.
I believe the 2 most important you should consider are;

1. If you lose your job, you must repay the loan immediately.
2. Yes you are paying the interest back to yourself but, you are losing whatever interest you would have made on the money you take a loan of.

Dave

salmonslayer · #11 04/10/11, 10:11 PM

Quote:

Originally Posted by Forest

I don't know what your 401(k) is invested in, but make sure that you include the lost investment gain in your calculations. If you loose a return of say 8 % on the money that you need to borrow, that's a very expensive loan you are taking out. Also don't forget the compound interest.

Thats what I was thinking too because you dont earn on the amount loaned. My wifes earning a pretty good percentage on her 401K so that would have to be calculated into the decision.

Beeman · #12 04/11/11, 08:42 AM

Did you cut the credit cards into little pieces and stop spending on them?
If you're thinking of retireing at 60 maybe you should be giving us advice.

Fat Charlie · #13 04/11/11, 08:51 AM

Quote:

Originally Posted by Forest

If you loose a return of say 8 % on the money that you need to borrow, that's a very expensive loan you are taking out. Also don't forget the compound interest.

Quote:

Originally Posted by switchman62

2. Yes you are paying the interest back to yourself but, you are losing whatever interest you would have made on the money you take a loan of.

What kind of interest rate would you be looking at on the 401k loan? If you're getting an 8% return on your 401k and take out a loan at 8% then you break even. Your 401k doesn't know or care if that 8% is coming from a mix of mutual funds or from a personal loan to you.

Even if your loan rate is less than what your 401k is making, don't forget to calculate the interest you're now not paying on the credit card debt. By the time the balance is big enough to be something where you're asking for advice, it's probably a big problem and you're not paying those pretty interest rates that they advertise. I've never seen a 401k return anything like the interest that credit cards charge. Even losing a few percent on your 401k return is a deal if you've eliminated debt charging you 30% or more. I'd rather pay 8% to the Fat Charlie Retirement Fund than 30% to Capital One. Heck, I'd rather pay 30% to the Fat Charlie Retirement Fund than 30% to Capital One. If I had to pay through the nose, I'd like to be the one benefiting from it.

switchman62 · #14 04/11/11, 09:07 AM

Quote:

Originally Posted by Fat Charlie

Your 401k doesn't know or care if that 8% is coming from a mix of mutual funds or from a personal loan to you.

???????????

If I had a choice of giving myself 8% or someone else giving me 8% I know which I would choose.

Dave

ronbre · #15 04/11/11, 09:56 AM

getting out of debt is the best feeling..do it

Hazmat54 · #16 04/11/11, 11:37 AM

Thanks for all the replies. I do need to live more frugally. Never been married, no dependants, never any pressure to live frugally. Charging them up after I pay them down would be bad. I might not be able to retire at age 60, but I hope for the debts to be paid down by then. A 401k loan has to be paid back immediately when you retire? The account is with DWS, not my employer. I hope the plant doesn't shut down and leave me unemployed. They shut down some other plants last year, but they say ours is doing well.

Things to think about. I was also building a pension benefit but they froze that at the end of last year. I should get a statement soon telling me what the monthly amount will be if I retire at age 62. I have been watching my spending, trying to plan ahead and make my own meals, not just pull into some fast food joint. The interest charge on the CC's each month was bugging me, which is why I thought of using the 401k to pay it down.

Thanks again everybody.

Scott

Fat Charlie · #17 04/11/11, 01:08 PM

Quote:

Originally Posted by switchman62

If I had a choice of giving myself 8% or someone else giving me 8% I know which I would choose.

If I had a choice of giving myself 8% or giving Capital One 30%, I know which I would choose.

The choice here isn't who pays you your interest but who you want to pay your interest to. The debt carries interest regardless of who you pay. If you insist on paying whatever interest rate the credit card wants, then I'm sure you can get your 401k administrators to arrange for the loan from your 401k to be at that same rate. You'll be happy twice- because you're still paying an obscenely high rate on your debt and because part of your 401k is doing a lot better than it had been!

Joshie · #18 04/11/11, 01:34 PM

Every financial adviser I've heard said this is never a good idea.

switchman62 · #19 04/11/11, 02:12 PM

Hazmat54-

I'm not sure about having to pay it upon retirement but, I know the way I have always seen it stated is "upon seperation from the company" you must pay it back. Since you said the company had shut down other plants last year, I personally don't think you would want to take a chance going that route. Think about just contributing enough to max out the company match portion and putting the rest to the cc each month.

As Joshie stated above, "Every financial adviser I've heard said this is never a good idea."

Dave

Reptyle · #20 04/11/11, 02:24 PM

Quote:

Originally Posted by Fat Charlie

Taking a loan from your 401k is the right move. You'll be paying a lower interest rate on the debt, and you'll be paying that interest to yourself anyway. Income tax on the loan repayment money is irrelevant- you've paid income tax on the money you're mailing to the CC company too.

Ditto.

Besides, if your 401(k) portfolio has been suffering, as many have, or if you're invested conservatively, then the interest you pay yourself will only bolster your returns.

I think many financial advisers have changed their tunes...The honest ones anyway...

ETA: This will only be a good idea if you're sure that you can keep from charging the credit cards up again...if you take out a loan to pay them off and then charge them up again, you have only compounded the problem.