I get mixed answers about my 401 k?

Question

What are the pros and cons to borrowing money from your 401 to pay off high interest credit card debt. I would like to retire in 3 years but I have a lot of debt I could pay off by borrowing from my 401k. I know I will lose the earnings on the money I take out but the interest I am paying on the debt is more than the earnings from the 401k. The way I see it, I can retire with debt or retire with less money in the 401k.

I guess I should have added , the interest earnings on the 401k is low compared to the interest rate on the debt, however because the balance is high in the 401K although the earnings are lower they can be substancial. I guess it goes back to the math!

Answer 1

It's usually never a good idea to take a loan from your 401k.

Also, if you take a loan from it and you are terminated or quit, you will be required to pay the loan back in full within 30 days.

I suggest that if you are in debt that bad, instead of taking the loan, how about TEMPORARILY stopping contributions to the 401k and apply that money to the debt. Once the debt is gone MAKE SURE to start the contributions up again.

Answer 2

Pros:
1. Borrowing Money at a lower interest rate
2. You borrow from yourself, so when you repay the loan, you are repaying yourself......not some bank
3. No tax consequences "initially" from borrowing from your 401k

Cons:
1. If you lose or quit your job, you'll have 90 days to pay back the loan otherwise it will be seen as a withdrawl and you
2. If you want to retire in 3 years AND pay back your 401k loan you will have a smaller paycheck the next 3 years as you will repay the loan back with after tax money and pay the money in bigger installments.

Looking at your situation, if you "believe" you have good job security and can live off a smaller paycheck, it makes sense to pay off some of your high interest credit card debt. This is because your investments are not giving you a better rate of return than the credit card interest you have to pay.

Answer 3

Simple ... you look at the one with the largest interest. If the interest rate on the debt is higher than the interest rate on the investment, use the investment to pay off the debt. However, don't forget to take into consideration any interest penalty you would have from using the 401K.

Here's an example ...

Interest in debt ... 15%
Interest you're earning on 401K ... 3%
Interest penalty for using 401K ... 10%

Now, subtract the Debt interest from the Penalty ...
15-10 = 5%

Since this is HIGHER than your earned interest (3%), use it to pay down the debt.

Answer 4

The only risk is should you become unemployed before the loan is paid off. In that case you owe all the money back almost immediately or face extreme tax consequences.