Is It Smart To Use Your Tsp Money To Pay Off Debt

If you are nearly retirement or take already retired, you lot don't want debt hanging over your head. Only if you lot haven't been able to pay off those nagging credit card bills, you may be wondering if you should dip into retirement money to rid yourself of those debts.

See also: Saving vs. Paying debt

In most cases, information technology's a bad idea to drain your 401(thou), IRA or other retirement assets to eliminate credit card obligations. That's considering if you're under 59 ½ years of age, you could confront a x pct tax penalty plus have to pay ordinary income taxes on any corporeality you withdraw.

All the same, there is i time when it probably is a good idea to use retirement money to pay off loftier-charge per unit credit card debt: It's when you're notwithstanding working, and tin can borrow money from an employer-sponsored retirement plan — and then repay the money to yourself without tax consequences.

Permit me explicate why this could be a practiced idea and how to go about information technology.

Assume you owe $xx,000 in credit carte debt at a xv percent annual involvement rate.

When to take money from your retirement fund and repay a debt- money under lock and key

Photo by: Perry Mastrovito/Getty Images

For every twelvemonth you let that debt lingers, y'all're forking over $3,000 in involvement payments lonely to a bank. That $3,000 translates into you making the bank $250 richer and yourself $250 poorer every single month.

So you'd be wise to consider tapping your retirement money to pay off those credit menu bills.

The question is: how should you go about doing this? Your choices actually boil downwards to two options: You can take a distribution or you tin can borrow money from the retirement program.

Don't Take a Distribution, Have a Loan

As mentioned, early withdrawals have serious tax ramifications. So a distribution is not the preferred strategy. Plus, taking money out of your 401(1000) permanently ways that you lose out on the hazard for those funds to grow over fourth dimension — which is the whole point of stashing abroad coin into your retirement nest egg. You desire those funds to appreciate over the years and to exist in that location for y'all once you finish working.

So over again, the borrowing route is more desirable, because information technology will strength you to supersede the money you have out.

But if you've already retired, y'all can't borrow coin from an employer-sponsored retirement account, such every bit a 401(one thousand), 403(b) or 457 plan. So this strategy volition only piece of work for people who are still gainfully employed and whose retirement plans at work let borrowing.

OK, back to our example. Yous've got $20,000 worth of credit carte du jour debt and that fifteen percent interest isn't making it any easier to pay off.

Your credit bill of fare visitor but requires that y'all pay 2 per centum of the outstanding residuum each month. In other words, your required minimum payment is $400 per month. At that rate, you'll pay off your $20,000 balance in 6 years and 7 months. And over that time, you lot'll pay a total of $11,577 in interest.

To avoid this scenario, accept a loan from your retirement program at work, simply only if:

Y'all tin set up a repayment plan that is three years or less
You reasonably confident that you will remain with the same visitor during that three-twelvemonth flow

The reason you want to limit the time your loan is outstanding is two-fold. Starting time, the sooner y'all repay the funds, the quicker they can brainstorm earning interest once again. Every bit important, though, you want to repay that loan as presently as possible to reduce the risk associated with you leaving the visitor for some reason.

When you lot separate from an employer for any reason — including termination or merely you getting a different job — whatever outstanding retirement loans generally come due. Sometimes, you'll accept 90 days or so to repay the loan in total. The specifics depend on your company's retirement plan. But whatsoever funds not repaid within a cursory, specified time period are typically treated every bit taxable distributions to you.

Y'all desire to avoid the IRS taxing y'all on whatsoever money you take out of a retirement plan for the purposes of reducing debt. And a loan from your retirement plan can exist the smart fashion to practise just that.

With a 401(g) or 403(b) loan, you pay yourself back the coin you borrowed plus you repay yourself involvement too. Best of all, the loan immediately gives you lot the economic do good of quickly reducing that high involvement rate credit bill of fare debt that's draining you financially.

Lynnette Khalfani-Cox, The Money Coach®, is a personal finance skilful, television and radio personality, and a regular contributor to AARP. You can follow her on Twitter and on Facebook.