Should You Pay Off Debt With Retirement?

The short answer is no. It hardly ever makes sense to pay off debt with retirement savings. If at all possible, you should use alternative savings or non-retirement assets to bring down your account balances and keep your retirement savings kept safely away.

Do Not Pay Off Debt With Retirement

There are number of penalties and income taxes associated from withdrawing funds from a 403(b) retirement account that can reduce the given wealth by at least 25%. Depending on your age and whether or not you are still employed you might also be subject to a 10% federal fee which is in addition to income taxes that would match your federal and state tax brackets.

Not only are you giving up money on the spot, but you are also giving up a great potential to make money in the future by choosing to pay off debt with retirement. The tax-deferred growth usually presents around a 5% return, so the more money you leave in your account, the better off you will be.

That sort of high interest rate benefits you, rather than using the money to pay off some low interest rate credit card.

The 10% federal penalty applies to workplace retirement plan holders under the age of 59, unless they fall under any of these specific categories:

You are older than 55 years old and are no longer with your employer.

An alternate payee receives a distribution (like an ex-spouse) due to a Qualified Domestic Relations Order.

You participate in an employee stock ownership plan that distributes dividends.
Certain cases of death, disability, and financial hardship

It all comes down to the amount you need to pay off debt with retirement, though. If the interest rate is high and you cannot pay it down with your current income, you might explore some other options before you pay off debt with retirement funds. Mutual funds and Roth accounts are better sources of money because Roth accounts do not penalize withdrawals as long as you take an amount equal to what you’ve contributed. In fact, once you are past 59 years old and the account has been opened for five years or more, you can use your Roth funds without owing any taxes on it at all.

With these alternatives in place, it is usually smart to make retirement savings a last resort for financial hardship. Leaving your money in those accounts is the safest bet, but of course be sure to talk to a financial specialist before making any major decisions.

This article by Michael first appeared on Debt Know More and was distributed by the Personal Finance Syndication Network.