Is cashing out my 401k to pay off debt a good idea?

Although you may have good intentions to pay off debt using a 401k, it is rarely a benefit to do so. There are several reasons to not do so, in fact. You will find that in some cases, it can be a benefit, such as if you are trying to save your home from foreclosure. However, keep in mind the long term implications of withdrawing those funds and how it can affect your future.

When To Cash Out A 401k

There are rare cases in which cashing out your 401k makes sense. Keep in mind that any unacceptable form of distribution not only causes the normal tax rate to be applied to those debts, but it also leads to a 10 percent penalty tax applied to those funds. That means a serious payout to the IRS before you even get the money.

  • If you cash out your 401k, you are costing yourself all the withdrawn funds, the 10 percent penalty and normal income taxes on those funds.
  • You lose out on the money you would have earned if you allowed the funds to remain in your retirement account earning interest.
  • Creditors are unable to go after your 401k account. Even if you file bankruptcy, creditors are unable to touch retirement accounts.

In the long term, debt settlement or even bankruptcy may be better options for individuals over withdrawing funds from a 401k account. Discuss the reasons and the options available to you by paying back debts in other forms. In some cases, not paying back the debt is a better option. 

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