If you’re facing high-interest debt and looking for ways to pay down what you owe, a loan from your 401(K) or individual retirement account (IRA) loan may seem like the obvious answer for paying off debt — after all it’s your savings. Borrowing from those accounts should be the last option to consider.
What you need know about a 401(k) plan or IRA loan
It is possible to borrow from a 401(k) plan. However, while most plans allow borrowing, it’s best to contact your plan administrator to learn more about the details of such a loan (e.g., qualifications, interest rate, payback period, etc.). If you rolled the 401(k) assets into an IRA, you would not take a loan from the IRA. You can only take money from an IRA for qualified purposes. Paying off debt is not one of them. Instead of a loan, the transaction would be deemed a distribution. Also you would be taxed at your ordinary income tax rate, plus be assessed a 10% penalty.
Just don’t do it
You have taken this important step toward saving for retirement. Now is not the time to get off course. Savings are most commonly achieved through employer-sponsored retirement plans and traditional and Roth IRAs. The federal government allows for taxes on earnings to be deferred to a future date — namely, retirement. Money that goes into employer-sponsored retirement plans and into IRAs now grows tax deferred, allowing for greater accumulation of funds during your earning years. It also allows you to manage your tax obligation in retirement. By taking an early distribution you defeat your reason for saving and you’ll get a penalty to boot. So resist the impulse to tap into a retirement account too soon.
Since a 401(K) loan is not advisable, take time to consider an alternative to paying down debt. Debt consolidation or a secured loan with a friendlier interest rate to pay down or pay off debt is a better plan of action.
Article provided by Local Government Federal Credit Union.
The advice provided is for informational purposes only. Contact a financial advisor for additional guidance.