Should You Pay Off Credit Card Debt with a 401(k) Loan

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If you’re struggling to pay off credit card debt, then you’re likely looking for any solution possible to get rid of this debt for good. Out of all the different options you could choose to help you pay off your debt, taking out a loan against your retirement plan is a solution that you should be cautious about choosing.

While taking out such a loan can certainly help you get rid of your debt, it can also put your future in jeopardy if you’re not careful. Here are some of the pros and cons of taking out a 401(k) loan to pay off credit card debt that you should consider before you choose this debt relief option.

Do You Have Other Options?

Before you take the leap of getting a 401(k) loan, you should research if you have other options to help you pay off your credit card debt. Taking one of these loans should not be done lightly, as they may end up mortgaging your future for your present. Fortunately, there are several methods you can try to get rid of your debt before you are forced to use a retirement plan loan, such as:

Should You Pay Off Credit Card Debt with a 401(k) Loan
  • Transferring your credit card balance to a lower interest credit card.
  • Selling assets.
  • Secondary employment.

First, you should check both your credit score and the outstanding balance of your credit card. If your credit score is strong, but your balance is very high, you may be able to pay off your debt by transferring the balance to a new card with a lower interest rate. Your monthly payments will be the same as before, but because the interest rate will be lower, you should be able to pay off the debt much quicker on the new card.

Selling assets is another option you should consider to pay off your debt before taking out a 401(k) loan. Almost everyone has something lying around the house that they don’t use anymore, and selling off these items may help raise the money needed to get rid of credit card debt. For instance, if you have collectibles that are worth something, selling these possessions can help you clear your debt without the need for a loan.

Finally, if it’s possible, you may want to consider taking on a second job to help you pay off your credit cards. If you have some free time every week, and a marketable skill, you can work a few extra hours and use this money solely for your debt. Even if you’re only able to earn a little bit extra, this money can help you work towards your debt without putting your retirement plan at risk.

Pros of a 401(k) Loan

The most common reason that people consider using a 401(k) loan is that they can no longer manage their credit card debt. If you’ve reached this point, one of these loans can be beneficial in several different ways. Let’s take a closer look at these benefits so that you can decide if a retirement plan loan might be the right option to pay off your debt.

Your interest rate is the primary benefit of a 401(k) loan. Generally, interest rates for one of these loans are much lower than most credit cards, which means you should have an easier time clearing your outstanding balance. Also, you will pay the interest into your account, which means you’re not having to deal with a creditor.

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Preserving your credit score is another big advantage of taking a loan against your 401(k) plan. If you fail to make payments with other loans and credit cards, your credit score will be negatively impacted, and your future financial standing will be at risk. This isn’t the case with a 401(k) loan, as credit bureaus do not receive reports about these loans.

Retirement plan loans can also be paid off easily and quickly. First, assuming you’re still employed by the company that offered you the 401(k) plan, loan payments will be taken automatically from your paycheck, meaning you won’t have to worry about missing a payment. Second, because these loans have a five-year maximum term, you’re likely to pay off the loan sooner since you know that there’s a firm deadline.

Cons of a 401(k) Loan

After reading the advantages of a 401(k) loan, you might be convinced that taking out one of these loans is the best way to pay off your credit cards. Before you take your loan, however, it’s crucial that you consider some of the disadvantages. For some people, a 401(k) loan is a good choice, but for others, it can be a serious mistake.

Tax Implications

Your employment status should be the determining factor in whether or not you take out one of these loans. If you’ve been thinking about leaving your job or there’s a chance you could lose your job while the loan is still in place, then you should choose a different option for paying your debt.

In most cases, the time you have to pay off a 401(k) loan will shorten if you leave your company. If you can’t pay the loan in this time frame, the Internal Revenue Service (IRS) will be alerted to the outstanding balance of the loan, and the remaining balance will be considered an early retirement plan distribution. For people under 59.5 years of age, a 10% tax penalty will apply for the early distribution.

Missed Market Growth

One of the most important things to understand about a 401(k) plan is that it is tied directly to the market. If the market goes up, then so will your 401(k) plan, meaning that you’ll have a more comfortable retirement.

If you take a loan against your plan, then you’ll miss out on market growth for as long as the loan is outstanding. Contributing to and holding on to your plan is the only way to take full advantage of market growth.

Bankruptcy Won’t Clear the Plan

Another disadvantage of 401(k) loans is that they usually won’t be cleared by bankruptcy. Declaring bankruptcy can discharge a variety of debts, but not retirement plans. If you end up not being able to pay off your debts and need to declare bankruptcy, you will still need to pay for the loan after the bankruptcy process is complete.

Solvable can help you find a solution for paying off your credit card debt. Our website features reviews of leading debt relief companies, and we can help you connect with the option that best fits your debt situation.

 

Jill Bridges
Author:
Jill Bridges

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