Why using retirement funds to pay off credit card debt is a terrible idea

Are you struggling with credit card debt and feeling pressured to pay it off as quickly as possible? You’re not alone. In fact, the average American household carries over $6,000 in credit card debt – and more people are taking extreme measures to get out of debt, including using their retirement funds.

That’s a big mistake. 

According to a recent survey, more than 25 percent of Americans have dipped into their retirement savings to pay off debt, including credit card debt. Sure, this may provide temporary relief, but it can have serious long-term consequences. By withdrawing from your retirement funds, you’re not only losing out on the potential growth of those funds but also facing significant penalties and taxes.

That said, alternative debt repayment strategies can help you become debt-free without risking your retirement funds. 

Quick fix, long-term problems

Using your retirement funds to pay off credit card debt might seem like a quick fix to a daunting problem, but it can have serious long-term consequences. In fact, it’s one of the worst financial decisions you can make.

First and foremost, using your retirement funds means you’re taking money out of a tax-advantaged account that’s supposed to help you build a nest egg for the future. By withdrawing some or all of that money, you’re sacrificing potential long-term growth and losing out on the compound interest.

Furthermore, taking an early withdrawal can result in significant penalties and taxes and missed opportunities to save money on taxes through contributions. You might also face limitations on how much you can contribute to your retirement accounts in the future.

A recent survey found that almost half of those who withdrew money from their retirement funds to pay off debt later regretted doing so. Furthermore, a 2019 report found that 20 percent of people who tapped their retirement funds for credit card debt ended up with an even higher balance on their credit cards a year later.

What happens when you withdraw the money?

Suppose you’re a 40-year-old with $50,000 in a 401(k) plan and $10,000 in credit card debt. You’re struggling to make payments on your credit card, and you’re worried about the interest and fees piling up. 

Eventually, you consider tapping into your 401(k) to pay off the debt.

However, if you withdraw the 401(k) money to pay off the credit card, you’ll not only face a 10 percent early withdrawal penalty but also miss out on potential growth of that $10,000 over the next 20 to 30 years until your retirement. Assuming an average annual return of 7 percent, $10,000 could grow to more than $76,000 in about 30 years.

Moreover, you might have to pay federal and state income taxes on the $10,000.

The negative impact can be significant regarding lost earnings potential and additional taxes and penalties. It’s important to consider the long-term consequences of such a decision before taking any action.

Other Debt Repayment Strategies

However, other debt repayment strategies could help you repay your credit card debt without jeopardizing your retirement funds. Below are a few options worth exploring:

• Balance Transfer Credit Cards: Consider transferring your credit card debt to another credit card with better interest. A word of warning: Many credit cards come with transfer fees and might also include increased rates after their introductory period ends.
• Budgeting: Establishing and adhering to a budget helps you prioritize expenses and find ways to cut unnecessary spending. By redirecting some of your money towards credit card payments instead, you can make progress on debt without jeopardizing retirement savings. The best part? You can find a number of debt management apps these days.
• Debt consolidation loans: Debt consolidation loans can help you consolidate multiple debts into one loan with a lower interest rate and simpler payments, potentially saving money and streamlining payments. That said, consolidation loans may come with origination fees and longer repayment terms than your existing debts.

Of course, those are just a few strategies; your particular approach largely depends on your financial situation. 

Here are some tips and resources to implement these strategies effectively:

• Research terms and fees: Do you understand the terms and fees involved? Don’t commit to a balance transfer card or debt consolidation loan until you do.
• Set goals: Consider setting specific, achievable goals, like paying off your credit card debt by a particular date or reducing your interest payments, etc., to keep you motivated and on track.
• Seek help if needed: Connect with a financial advisor, credit counselor or debt attorney if you’re struggling to make progress or need additional guidance. Click here for more information from the Van Horn Law Group.

Remember, the key to paying off your credit card debt without sacrificing your retirement funds is to be patient, persistent, and strategic. 

Make strategic decisions, not hasty ones!

Credit card debt can be crippling. 

For starters, you have to deal with high-interest charges, making it harder to crawl out of debt. Credit score? Forget it. That sterling 700-plus score is so low that you’ll need help qualifying for loans, other credit cards or even rental agreements.

And then there are the bills that are becoming increasingly challenging to pay, which, by the way, also come with late or additional fees if you miss payments. Your limited financial freedom causes stress and anxiety. And emergency funds? Forget it; you’re just happy to avoid a negative bank balance.

So, of course, tapping into your retirement funds seems like your “get out of jail for free” card regarding those debts.

But those hasty, short-term “solutions” can have lasting impacts.

If you’re struggling to see the proverbial light at the end of the debt tunnel, contact us at the Van Horn Law Group. We have years of expertise in helping others gain freedom from debt and are dedicated to finding the best legal solution for you.