Should I take money from 401(k) or take cash advance from credit card?

In My Humble Opinion
1

I’m in a bit of a financial bind now, having been unemployed for over a year. Severance has run out and unemployment has run out. I have two main options for paying my mortgage next month - draw money from my 401k or a cash advance from a credit card. A third option was the MegaMillions lotto a couple weeks ago - didn’t work.

“Everyone” says it’s horrible to take money from a 401k, but unless I’m missing something, it will be taxed as if it was payroll since it was a pre-tax deduction from my paychecks, and the IRS puts on a 10% penalty. A 401(k) withdrawal is not paid back, so whatever I take out will be immediately and fully usable to pay bills, and I’ll probably be able to get back some amount of the regular tax next year, so the maximum effective “interest rate” on it is that 10% penalty…

A cash advance has no tax or penalty, but it does have interest, and it does need to be paid back. I’d have to take more money than I need to cover the mortgage, utilities, etc. so I’d be able to make the payments on it at probably 20% or more. I’m not seeing any great advantage to that.

For now, I’m ignoring any effects on retirement - today’s crisis is having enough in the bank to cover bills. Other than the mortgage, I have little debt, so trying to “free up” cash flow by only making minimum payments won’t be very helpful.

2

I think the 401(k) withdrawal would be better. Otherwise all you are doing is taking a loan at what is likely a low rate (mortgage) and turning it into a high rate loan on a credit card. Nothing good comes from that.

It sounds like you still have the 401(k) at your old employer and didn’t transfer it to an IRA. If so, and if you were 55 or older when you became unemployed, the rule of 55 may get rid of the 10% penalty.

And you didn’t ask, so feel free to ignore this if you want, but unless you have enough in the 401(k) to cover the mortgage, or get a job soon, you may want to consider if keeping the house is a good idea or not. Doesn’t make sense to drain a 401(k) to pay for a house that you may not be able to keep.

3

Moved from FQ to IMHO.

4

That was my early retirement plan. Didn’t work for me either.

Generally speaking it is a bad idea to withdraw money from a 401(k), partly because of the penalty and partly because you tend to make things worse for yourself in the long run.

In your case though, you’re not using it to cover credit card debts or buy something optional. You need to pay your mortgage. That’s not an option. And in this particular case, using a credit card is paying one debt by racking up a worse debt. Like @Dag_Otto said, you’d be taking a low interest loan and turning it into a high interest loan. In the long term you will definitely make things worse for yourself by paying with the credit card.

My opinion: Take the 401(k) withdrawal.

5

You MAY be able to avoid the 10% penalty if you qualify as a hardship withdrawal. From the sounds of your situation, I would try that route.

6

What kind of equity do you have in the house? How much do you plan to take out of the 401(k), how much will still be in it, and how much time does that buy you? What is your plan to secure your finances going forward?

If you’ve been unemployed in this economy for over a year, what are your employment prospects? Frankly, they don’t sound good and I have to wonder why. It’s not hard to find paying work these days. The only way I would choose to take out a credit card advance to make my mortgage payment this month is if I had a very real likelihood of getting a solid job within the next month that would allow me to meet my ongoing obligations and pay off the entire credit card balance within the next 4-6 months. Trying to float your housing payment on the credit card is just going to dig you into a hole from which you will otherwise not be able to escape.

I’ve got over 50% equity in my house and it’s in a desirable neighborhood. It needs work but I could sell it quickly for a fair price. I might take money out of my 401(k) to preserve my house but then I would have to decide what to do with the house. If I didn’t have a real plan to be able to pay for the house going forward, including taxes and maintenance, I would plan to sell it, cash out my equity, and move into cheaper rental accommodations. It’s not what I want to happen at this point in my life but it beats cashing out my retirement fund to hold on for a few more months before I later give up the house and whatever equity I have to the bank. At that point, I will have thrown away my retirement account just to keep renting my house for a short time. Better to look at my future clearly now and make the hard decisions before I have no options. Good luck.

7

You say that the effective interest rate on your 401k withdrawal is only 10%, but it also should include the lost earnings you will forgo on not having that money in your 401k plan. If the market continues to perform like it has over the last 6 months that may not be a bad thing, but since the end of June the market is up approx. 13%. If it continues, and you take your money out, then your effective interest is about 23%.

I also echo @Tired_and_Cranky 's thoughts on the amount of equity in your house. Would you be able to get a HELOC (home equity line of credit) loan, which should have interest rates similar to your mortgage rate?

Also, given the current low unemployment rates in the US, and everywhere I look is hiring people, why are you having such a problem finding work?

8

Take in a roommate. Good housing is hard to find. My brother did this and it saved his home until he was able to retire. Then he sold it and downsized.

9

Another great idea!

10

Depending on your age there is also IRS code 72(t). That’s what I did.

11

Very good advice.

12

You can also borrow from your 401k. You would pay yourself back with interest (the interest goes into the account). There are 5 year and 30 year loans and there are specific rules regarding each one.

13

I thought only current employees could take loans from 401(k) accounts.

14

I wasn’t aware of that but you’re probably right. They would want you to have the income to pay them back.

15

Taking a loan on the 401(k) is impossible if I’m not employed. As it is, I had an existing loan on it that was converted to a distribution. Three years ago, replacing a loan at 21% with one at 7% made a lot of sense but I was not expecting to be cut loose without warning.

Can I get a job? Sure. I can walk into pretty much any fast food place and maybe get a minimum wage job that will leave me in a lot of pain*, depending on how desperate they are. I’m at the awkward age where they’d correctly assume that I’ll dump them as soon as I find a better position, so they’re not anxious to spend the time and cost to onboard and train me. Plus, up until a couple of weeks ago, taking a minimum wage job would stop the unemployment.

As for finding a position in my field, anyone could look at my resume and deduce that I’m older than 45, so that’s one challenge. It’s not difficult or illegal to see 21 years at one employer in an advanced level position and assume I didn’t start that position fresh out of high school. The other side of the double whammy is I don’t have a degree, so the overwhelming majority of positions are out of reach as they require a BS in computer science or something adjacent.

The HELOC landscape is very different than three years ago. A year ago, it was virtually impossible to get one in any amount. Today, it’s still very difficult as no national banks I’m aware of are offering them. Another strike against them is they’re another debt to be paid.

Hardship withdrawals - those are limited to the amount it takes to satisfy the actual amount needed to avoid foreclosure, which means foreclosure proceedings have started after being delinquent for a few months. I can’t just say “I’ll need x thousand to pay my mortgage for the next couple months.”

As for 72(t) withdrawals, it looks like I’d be able to get a couple thousand per year, so not really worth pursuing.

*Had I known 15 months ago how bad things would be, I would have had my doctors initiate the lengthy process to hopefully get me declared disabled with Social Security due to my spinal injuries. Coincidentally, I had an epidural injection today, and will have some nerve ablations next month.

16

Yes, loans are 100% better than withdrawals if allowed, but that’s irrelevant here.

See here on Safe Harbor Distributions. Because you have an immediate financial need to keep your house, it’s probably allowed. But it doesn’t appear to be an exception for the 10% penalty, and some states may have an additional penalty. If you go this route, when it’s time to file 2022 taxes, you’ll probably also want to set up a payment plan, which is fairly generous compared to simply not paying on time and collecting interest. Whatever you do, you should absolutely file your taxes on time, even if you’re not sending it with a check. The “didn’t file” penalties are steeper.

Much of this should be addressed with your 401k servicer.