I received a question last week from someone who wants to know if it is a good idea to withdraw money from their 401(k) plan to pay off debt. A question like this is always best taken on a case by case basis – so let’s see what we have.
My husband is putting in the max matched at his company 401k. Last year he pulled most of that ($34,000) and put it into a Traditional IRA. He put the IRA in a 7 month CD because he’s thinking about pulling $20,000 from it in July to pay off his truck and rolling the balance into a Roth IRA. He will continue to contribute to his 401k until he retires in another year. This is our plan at this point — what would you advise?
Hello, K, Thanks for contacting us.
First, I think your husband is doing the right thing by maximizing his contributions to meet the company match on his 401k. It’s always a good thing to take advantage of free money, which is what the company match is. But retirement accounts should never be interchanged with savings accounts or used for short term goals. Retirement accounts work best when used for one thing – retirement!
The government gives very nice tax deferral benefits for 401k plans and Traditional IRAs, and a different but just as valuable long term investment benefit for contributing to a Roth IRA. In exchange for giving you these benefits, the government places strict penalties for early withdrawals from retirement accounts – a 10% penalty right off the top, plus the immediate payment of taxes on the earnings (assuming the age requirement of 59 ½ is not met).
The information in your question is limited, so if the penalties do not apply because you have met the minimum age limits to withdraw the money, then you won’t have to worry about the early withdrawal penalties. But you will still need to worry about taxes which will be due upon withdrawal. My other concern is whether or not you have enough money put away for retirement. I recommend taking a strong look at your retirement plan and whether or not your finances will be enough to support you in retirement.
Pinyo from Moolanomy:
I don’t know your situation fully so it’s hard to give you a specific answer, but here are a few things to consider.
First, is your husband old enough to withdraw fund from traditional IRA without having to pay the 10% early withdrawal penalty? If he’s younger than 59 1/2 at the time of withdrawal, he will have to pay 10% penalty on top of the taxes on the $20,000. Probably something you want to avoid.
Second, aside from the 401k, will you have enough income during your retirement? $34,000 is not a lot of money and you may want to hold on to the money to cover your retirement expenses.
Third, do you have an emergency fund in place? If you don’t have one already you may want to consider keeping the $34,000 or the remaining $14,000 as your emergency fund. A good place to keep this fund is in an online savings account due to the liquidity and still decent interest rates.
Whatever you decided to do, good luck.
Plonkee from Plonkee.com:
There are serious penalties for withdrawing money from tax advantaged accounts. Unless you’re faced with serious financial problems such as imminent bankruptcy that effects your employment or similar, I’d suggest that withdrawing money from an IRA is a not a good idea.
I’m unsure that you are going to have enough money to retire on. If you withdraw money to pay off the balance on the truck, that’ll leave you in the region of $15k plus social security (unless I’m missing something). The income you can generate from $15k for an extended period of time is around $50 a month. Have you had an estimate from the Social Security website to see what you are likely to qualify for?
Thanks for contacting us, K., and I wish you and your husband the best in your retirement plans.