I have $125,000 in a Roth IRA. I owe around $90,000, total, on credit cards and a home equity line I tapped for a business that has not worked out. I cannot afford the payments on my debt. Should I tap the IRA to pay the debt, or should I look at some other option? I rather not declare bankruptcy, if possible.
Since you don’t want to declare bankruptcy, your question is basically, “Is it wise for me to use Roth IRA to pay off debt rather than debt settlement or consolidation?” The answer is, “it depends.”
Many people say to never use retirement savings to pay off debt. I disagree; there are times when it may be appropriate. The key issue is to analyze your all in-return from paying the debt vs. the all-in return from keeping the money in the account. Leaving aside the early withdrawal penalty, if your IRA is currently earning 4% and your debt is costing you 9% - 10%, you would do better—twice as well, on a strict economic basis—by paying down the debt. Of course, you do need to factor in the early withdrawal penalty, which will reduce the advantage of using the Roth money—to pay down $90k of debt, you’d need to spend $99k from the Roth.
The fundamental calculus, then, involves looking at rate of return on the investment vs. the cost of the debt. Remember that saving 5% on $1,000 is exactly the same mathematically as earning 5% on $1,000, so you can simply compare the effective interest rate or rate of appreciation on the investment vs. the interest rate on the debt. (While it is true that investments compound—they don’t merely earn simple interest—most debt also compounds, so the comparison is still fair and equivalent.)
You also need to factor in a whole host of other factors, including:
1) Your age—how long until retirement? How long will you have to save more for retirement? You must make sure you have money to support yourself in retirement.
2) Your risk tolerance—paying down debt is a guaranteed return, while even the best investments contain some element of risk.
Now, comparing using your Roth vs. debt settlement: debt settlement will have a negative impact on your credit rating but will reduce how much you owe; successful debt settlement, especially if you use a reputable debt settlement company or an experienced attorney to negotiate it, one that does not charge you an arm and a leg, can represent a huge economic gain—the savings are money in your pocket (though you may have to pay taxes on any forgiven debt). If you are not too worried about your credit rating, it makes sense to look at debt settlement as an option. If you can’t negotiate settlement, you can always try something else.
Using Roth vs. debt consolidation: consolidation is taking out a new loan to pay off the old loans. While, if done right, it will reduce your interest rate and/or monthly payment, it does not actually reduce how much you owe. If you are finding the debt unsupportable, it may not help you much.
You mentioned that you do not want to declare bankruptcy. However, you should probably at least consult with a bankruptcy attorney and consider the option. IRAs are protected in bankruptcy, so it would potentially let you discharge you debts while protecting retirement savings. There are negatives to bankruptcy, and you also have to be sure you qualify, so this might not be right for you—but it is worth considering.
Talk to a Debt Settlement Lawyer before you make any decisions. He or she will be able to guide you to the right solution for your situation.