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  3. Should you pay off debt with your retirement account?

Photo of a couple considering using their retirement accounts to pay off debt.

Should you pay off debt with your retirement account?

The average American works about 34 hours a calendar week,ane reads 12 books a yr,ii spends five to six hours on screens per day—threeand has debt. In fact, if you're like most Americans, y'all have more than $90,000 that yous owe on credit cards, mortgages, student loans, and more than.4

On the flip side, though, if yous've started saving for retirement, you may have made good progress. For example, the average working household ages 45–54 with a 401(one thousand)/individual retirement account (IRA) has accumulated a remainder of about $106,000.5

If you're trying to leave debt, those retirement savings are tempting. "We sometimes think, I accept these retirement savings at my disposal," says Stanley Poorman, financial professional with Main®. "Merely that's there for retirement. There are other tools to use."

In fact, raiding your retirement savings to pay off debt may equal more short- and long-term costs than you lot realize. Hither are some tradeoffs to consider.

You'll pay penalties and taxes for using retirement savings to pay off debt.

Every retirement account—a traditional IRA, Roth IRA, and 401(grand)—has age distribution limits. That means some combination of penalties and taxes may hit yous for early withdrawals.

Account type Early withdrawal costs
IRA You'll get dinged with a 10% penalty on the full amount you withdraw, plus taxes at your current income taxation bracket. (Some exceptions to the penalization accuse, like using funds for a first-time homeowner down payment, use.)
Roth IRA Information technology'due south important to distinguish between contributions and earnings for a Roth IRA. You tin withdraw the former at any time and whatsoever historic period, tax- and penalty-costless (call up, you've already paid taxes on Roth IRA contributions). If you withdraw earnings at any time, you must pay taxes on them. If you make a withdrawal before the account is five years old, yous'll pay a 10% penalisation and taxes.
401(k) You'll pay a 10% penalty on the withdrawal plus taxes at your current rate.

Let's say that you have $20,000 in credit bill of fare debt. What are the true costs (and how much will you lot really encounter) if yous withdraw from a 401(k) to pay information technology off?

Graphic showing a $20,000 withdrawal with a $2000 early withdrawal penalty minus a $4000 income tax will net $14,000. If you have $20,000 in debt, you will still be short $6000 after withdrawal.

The takeaway? You'll need to withdraw even more than than you think to comprehend your debt and all the penalties and taxes.

Photo of a mother holding her baby while looking at options for emergency cash.

Y'all may lose out on potential earnings if you employ retirement savings to pay off debt.

If you withdraw that $xx,000 to pay off debt, y'all're also eliminating the opportunity to grow those funds over the long-term—otherwise known as compounding interest.

Graphic showing if your retirement balance is $20,000 multiplied by 20 years with a 6% growth rate, your ending balance will be $64,143.

"Weigh all the impacts," Poorman says. "Some impacts you tin can recover from, and some you may not. Can you really ramp up your retirement savings charge per unit to recover? You may be giving upwards substantial returns, yr over year."

You'll accept to conform your upkeep if you have a 401(k) loan with retirement savings.

If you lot don't have another choice for your debt simply are wary of withdrawing from your retirement savings, you lot may consider a 401(k) loan.

  • Limitations: Upward to 50% of savings or $l,000 (whichever is less), in a 12-calendar month period. Some plans don't let 401(thou) loans.
  • Payback: Inside five years and with involvement, which goes into the 401(k); if you get out your job, you must pay back the loan first.
  • Taxes and penalties: None if y'all meet the terms of the loan. If y'all don't repay the loan, you lot'll exist charged taxes and penalties.
  • Costs: You'll miss out on possible account growth during your loan repayment flow.

Caution is key, Poorman says: A 401(thou) loan is but that—a loan—and so you'll be required to brand monthly payments. "That will reduce your monthly income, so brand sure it doesn't put you in a worse situation for the firsthand time to come," he says.

Photo of a woman smiling at baby while she works on a laptop.

Each calendar month you have income that you can divvy up yet you desire—retirement, vacations, dinners out, and more. "It'southward all about tradeoffs," Poorman says.

Your coin is a tool for yous to residuum those tradeoffs and achieve your goals. Fundamentals—a budget that aligns with your income and expenses—tin help. And you may take debt repayment choices that help ease some of the pressure, Poorman says, including consolidation or negotiating with a creditor to figure out a reasonable repayment schedule.

"You lot want to review every other option showtime," Poorman says. "Would you lot have to work longer to make up those funds yous withdrew? Would you end upward in a like situation a few years from now?"

Photo of a man researching different methods to pay off debt..

1 BLS
2 Penn Book Center
iii Statista
4 Debt.org, CNBC
5 MarketWatch, National Retirement Risk Index
vi U.s.a. SEC

The subject matter in this communication is educational only and provided with the understanding that Principal® is not rendering legal, bookkeeping, investment or tax communication. You should consult with advisable counsel, financial professionals or other advisors on all matters pertaining to legal, tax, investment or accounting obligations and requirements.

Investment advisory products offered through Principal Brash Services, LLC. Principal Brash Services is a fellow member of the Principal Fiscal Group®, Des Moines, IA 50392.

2076679-032022