I am 36years old and have approximately $57, 000 in a 401k plan I was awarded in my divorce 2 years ago. I want to pay off some debt by withdrawing $17,000 from the plan. My current job offers a 401k but I have not since participated in it. I really want to be debt free since I have a new start on life and a great new job. What do you think?

I think you should roll over the other 401K into your new company's plan, then take a loan against the funds to use in paying off your debts. A 401K loan is simply borrowing from yourself. Everything you pay back goes back into your 401K including any interest charged.

Incurring the 10% penalty as well as the tax liability is just not a good idea.

Thank you ScottGem for the prompt response. I will take into consideration what you said and think on it some more.

Do you have any equity in your home?

I paid my mortgage off three months ago and still waiting for the title.

If you have a debt free home, you might also consider a home equity loan to pay off the debt. While I still think a 401K loan is better, what homeowner may be thinking is that an equity loan with its tax deductible interest, is another alternative.

What is your background? Just curious (not sharpshootin 'ya!)

I personally think that if retirement or financial independence is a goal for you, a home equity loan would be a better strategy -- especially if you are in a higher tax bracket -- for two reasons.

1. Keeping the money in a tax-qualified account will give that money the opportunity to grow.

2. The effective interest rate (after the tax deduct) should be somewhere below 5% if you have good credit. It could be even lower if you are in a higher tax bracket.


I don't have a financial calculator with me, but I can tell you that usually it doesn't make sense to invest in the market if you have high interest credit cards. This is because it's hard to count on a return that will beat the interest on the cards. But it isn't hard to beat the effective rate (you'll probably need to come up with more tax deductions than the interest on a 17K loan for it to make sense to itemize) on a home equity loan with a properly diversified portfolio over the long term -- right now you could do it with a CD! Even if you didn't deduct the interest, I'm confident that you would still come out on top. This isn't even taking the 17k that would continue to grow for you into account.

Talk to a local Financial Planner!

My background is very varied. But pertinent to this thread I spent 10 years in the field of benefits administration mostly with defined benefit and defined contribution plans.

While you have a point that the effective rate of a home equity loan may be low, its still costing the borrower. A 401K loan costs the borrower nothing. Any interest charged goes back into the account. The effective cost depends on what return the funds can get.

It costs the individual the oppurtunity of participating in the market. If historical statistics mean anything -- as long as we're working with ten years plus -- there will be more on the bottom line with the strategy I recommended. :D

Not necessarily. With your suggestion there are significant risk factors with mine there is none. I do agree that it's a alternative that should be explored, but whether it's the best alternative is a personal decision that should take a number of factors into account.

This I agree with.

[QUOTE=ScottGem]Not necessarily. With your suggestion there are significant risk factors with mine there is none. QUOTE]


The above I do not agree with.

http://www.investopedia.com/terms/o/opportunitycost.asp

I'm not referring to the definition of risk listed in that link. I'm referring to the risk of investment return. With a 401(k) loan, there is no risk of investment loss. There MAY be a risk of lost opportunity, but that risk exists in any decision.

This will be my last post. I came to this site because I wanted to see if I could fix my toilet on my own without paying a plumber -- bad idea (I got good advice on the toilet -- just... well, look at the username). I should have thought about that because I wouldn't recommend that someone try to get free financial planning advice. I would recommend that they pay someone who is a professional to help them. Maybe this is because that's what I do for a living -- but then again, after seeing some of your posts, I believe in what I do even more. It's nice of you to spend your time helping people out here, but I think in some cases you could be hurting more than helping. There are other options that would be better than what you recommended. Another one that I didn't mention would be balance transfers to 0% cards.

The point is -- I am a financial planner by trade and I would almost never recommend that someone take money out of their 401k to reduce their debt.

Whoa! When did I ever advise anyone to take money from their 401K to settle debts? If you check my responses to similar questions you will see I have ALWAYS recommended that people not take money from their 401Ks. But taking a LOAN from a 401K is NOT taking money from one. Its simply transferring funds from an investment account to a loan account. The loan balance becomes part of the 401k's value. The interest paid on the loan goes back into the person's account. Taking a loan just gives a person the ability to put more money into their 401K.

I partially disagree with that. Again, if you review my responses, I frequently recommend that someone see a professional to get help with an issue. That doesn't mean getting advice from a site like this doesn't make sense. Even if the advice is to seek professional help, frequently our advice can give the asker a better understanding of the issues involved. This way, when they do see the pro, they will be able to understand the advice being given and better able to make the best decision for them.

If you noticed, I never once said that your suggestion wasn't a viable alternative. What I tried to do was present the pros and cons of both alternatives. Your position was that the cost of the home equity loan could be offset by the earnings if the funds were left in the 401k investment vehicles. That position involves considerable risk. There is the risk that the returns earned by whatever investment vehicles do not offset the cost of borrowing and could even involve a loss. There is also the risk of losing one's home if finances take a downturn. This has to be weighed against the potential of increased earnings. My position is that a 401K loan involves no risk and no cost. The downside is the POTENTIAL loss of earnings.

There are risks involved with both strategies.

Here is a good article... Darn it! I can't let you have the last word.

http://www.stretcher.com/stories/980525a.cfm

BTW - Taking a 401k loan IS taking money out of it -- Now you just owe yourself money, and the interest is almost always very low. I've worked this calculation with clients many time, and it always works out that it's better to not do the loan *assuming a CONSERVATIVE 8% ROR* which will be easy since the individual is 36 yrs. Old. If not, then we might all be out in the streets throwing rocks at each other.

No a loan is NOT taking money out, its simply transferring the money to a different investment vehicle. But you are right, there is one risk involved, if you leave the company the loan has to be repaid or you get hit with penalties.

I'd have to see the exact numbers to see how they would work.

Inept homeowner is correct in my book, leave your 401K alone, and let it grow!

I have about $16k cc debt but a lot more in my 401k. I have been tempted to do the same but I have resisted only because of the penalty and taxes and it will leave less money that is compounding thereby reducing the total amount when retirement comes along. It's tough but I am finding ways to pay down my debt without tapping my 401K or IRA. Just another view piont.