Should I use my 401K money to pay some bills? (LONG)

In My Humble Opinion
1

Ok, so some backstory:
Having been an unwise, short-sighted, irresponsible American consumer, I got my first credit card in my early 20s. Through my careless use of it, I began racking up debt. I have done basically everything I now know that I shouldn’t have done - missed payments, used one card to pay off another, etc. I have had some amount of credit card debt hanging over my head for all of my adult life. Early this decade, it finally reached crisis level - I had $30,000 of debt spread out among a number of high-interest cards. (I was only earning $25,000 a year at the time.)

I learned the really, really, really hard way to budget my money. I kicked some very expensive habits, got on a debt management program and slowly, diligently chipped away at the debt. Now I only have one credit card to repay (just about $3000) that I am on a special plan: Citibank directly debits my account for $200 each month and charges me a special low-interest (about 4%) However, the terms of the deal are very specific - if I miss even one payment, my interest rate gets jacked up to “market rate” (at least 20%) Nor can I lower the amount of money they debit. So even if I do pay them, but fall short of the $200 mark, the deal is off. And I’ve already asked Citibank if that was negotiable - It isn’t.

One of the biggest down-sides to the repayment is that I have been unable to amass any real savings. Money I might have otherwise stashed away in a savings account I had to shell out to HSBC and Citi. The one pocket of savings I did have was my 401k plan at my most recent job. I only qualified for it a few years ago, and for the last year of my employment the company had stopped making matching contributions. So, my account is at present a little under $8000.

At present, I have been out of work five months. I have had one or two day-long temp jobs, but still no long-term prospects. My severance has run out, what little money I did have in the bank is running out, and at the moment I’m “on the dole” - My unemployment check is what I’ve got. I’ve done some number crunching and realized that even the $200 a month might be difficult to keep up.

My biggest fear is watching my interest rates spiral out once again. I’ve been in the situation before of really trying to pay off my debt, but looking at my bank statements and seeing that the amount of interest charged to my account far exceeding what I could afford to pay out. I am in real terror of having come so close to finally paying off my back debt, only to see my interest rates spike, and then be unable to keep up, and see my debt balloon upwards again. That very well may lead me to become suicidal.

Added to that is my Cobra payments. Because of a snafu in my paperwork (long story), my Cobra benefits were terminated. I contested the decision and they’ve agreed to reinstate me - but only if I come up with a payment to cover all four months (January - April) that I wasn’t making payments to them. Cobra is $492 a month - almost $2000 they want BEFORE reinstating me - money I don’t have. Health insurance is something that may seem un-necessary when you’re healthy, but when you need it - you damn well need it. I learned that the hard way too, but that’s a different story. So I have that to consider as well.

Anyway, back to my 401K. The market value has pretty much remained stagnant for several years and no new money is going into the account. Of course, it has occurred to me that were I to cash it out, I would have enough money to pay off my back debt once and for all, and get my Cobra benefits shored up. And there would still be a little bit left off for me to stash in an IRA or savings account and start paying into $200 a month into it, rather than paying Citibank. And $8000 is something that wouldn’t take too long to recoup.

But, it’s my only retirement savings. I’m 41, and I’m already way behind on putting together a nest egg. And I have considered that this idea of paying off my debt with my 401 is likely the same type of short-sighted, quick-fix thinking that got me into this mess in the first place.

But I just don’t know - what would really be the better option for the long-run: holding onto the money I have now, or eliminating my debt once & for all? Any way I look at it, I see a lot of pros & a lot of cons for either option. So, what’s your advice?

2

What are your options on getting money out of the 401(k)?

Do you have to withdraw the full amount, or can you take a loan for some arbitary amount? Also, what are the restrictions on getting a withdrawal?

As an example, my employer allows loans, which are paid back at decent rates - I just had a look, and the interest rate is about 8%, but withdrawals have to meet IRS guidlines for what are known as hardship withdrawals. In general terms, the money has to be to avert a financial catastrophe such as foreclosure or bankruptcy. Just paying off a credit card on its own does not qualify. Paying for health insurance/COBRA might qualify. Keep in mind there is a stiff penalty for early withdrawal that will hit you at tax time next year as that money went into the plan as a pre-tax deduction.

You’ll need to check with your plan’s administrator to get all of the rules and conditions for your particular plan - there’s no universal standard regarding whether or not loans are allowed.

3

Don’t worry about paying off the credit card early. You can pay it off later if you need to. If you were to skip a payment and they spike your interest rate, you could cash out your IRA and write them a check and close your account. Don’t pay it off early if you don’t have to. 4% rate is really good.

4

Have you looked at high-deductible health insurance? That’s what my self-employed boyfriend uses, his rates have been going up but they’re still well under $492/month. We’ve had a few threads in the past about shopping for it, I can look them up in you want.

5

I’m not sure of the answer to your current problems, but I did want to comment that you should be eligible for the American Recovery & Reinvestment Act’s COBRA subsidy where you’d pay 35% of your COBRA payments while your former employer would be reimbursed for the remaining 65% by the government. In case your company hasn’t discussed that with you or has given you standard COBRA rates (ie, rates that don’t reflect the subsidy), here’s a link to the Department of Labor’s Web site with details. Hopefully that can help you limit how much you owe to get your insurance reinstated, too. I’m not sure how it applies to reinstatement, but I hope it’ll help with some of the financial burden.

6

Talk to a bankruptcy lawyer.

I am not your lawyer, don’t want to be your lawyer, probably don’t have a clue what I’m talking about, and listening to me could get you bent, folded, spindled, mutilated, incarcerated, deported or otherwise inconvenienced.

That said, I don’t see much benefit in converting exempt assets–like your retirement account–which most creditors can’t reach, into non-exempt assets which every creditor could reach. You’ll likely have to pay taxes and possibly penalties for drawing the money out early, too.

7

Another vote for talking to an attorney (any general practice attorney can do it). My ex just did it and he was in a similar position. Yes it was his fault he got into debt, but on the other hand he can ill afford to lose what little he has, and the credit card companies certainly made plenty of money off him already.

8

You do realize that there are huge penalties for cashing out your 401k early?

9

Basically, your 401k is pre-tax, so any money you take out now would be taxed like regular income. But, since the amount you would take out is probably higher than your regular measly paycheck, the tax rate would be higher too (made up numbers - paycheck $600 - 12% taxes, 401k $5000 - 28% taxes). Also, the penalty is usually 10%, which you would have to pay to the IRS when you do your taxes next year. Do you think you will have that money sitting around next year at tax time?

So, using my numbers, you take out $5000, it’s taxed at 28%, and you pay IRS 10%, you are left with $3,600.

Not to mention the loss of investment over time because the money is no longer in the 401k.

10

If you do not cash in your 401(k), I recommend that you roll it into an IRA. You are almost certainly paying higher expenses in your 401(k) than you would with an IRA at somewhere like Vanguard or Fidelity.

11

You guys are telling them to file bankruptcy (which, depending on where the OP lives, could run anywhere from $1000-$2500) for a $3000 debt? That hardly seems worth it. I mean, when the OP owed 30k? Sure, but now?

12

And there could be state income taxes too. My Bro sez “Figure 50%”.:eek:

So, figure you’ll net around $4000. Is that enough?

13

Don’t think anybody is telling him to file bankruptcy. I probably came closest by suggesting he talk to a bankruptcy lawyer. Said lawyer would provide advice on his specific situation, considering the laws of his jurisdiction.

14

Fair enough. I misread.

15

I’ll cop to probably not fully absorbing all the pertinent facts in the really long OP. But, it sounds like you have some short-term cash needs (i.e., needs that will be fulfilled once you get a real job again). I would recommend looking for a really shitty job that you will hate instead of cashing out your 401(k).

16

Don’t touch your 401(k) unless you absolutely have to, and then only take out the bare minimum.

And ignore the “talk to a lawyer” advice. It would have made sense back when you had $30k in debt, but with only $3000 left to go, it doesn’t really make sense to do anything but just tough out the final stretch.

17

I agree on both of these counts.

It might be worth tapping for the COBRA in the short term since losing health insurance means you’re really SOL. FWIW, I wonder if with such limited assets etc. you might not qualify for Medicaid? I have no idea how that works though.

On the 3,000 debt: If your rate does adjust to, say, 20%, that’s 600 a year in interest. Or 50 a month in interest. If your monthly payment is 5% of the balance that’s 150 a month, of which roughly 50 goes to interest. I don’t know what your minimum payment would be of course, might be even less than 5%. Obviously in the long term, you’d spend a lot more in interest if it winds up switching back to market rates, but right now you need to preserve your cash flow.

I do agree that cashing out the 401(k) to kill that debt is not the best idea.

18

If you break the payment plan - do they come after you for old interest? Asking because that’s how a lot of “12 months same as cash” deals work - if you are a day late on the last payment, all of the accrued interest comes due.

If that’s the case with deal you have with Citi, it might change the advice.

But, in general, cashing out the 401k/IRA is almost always the wrong choice.

Joe

19

I used some of my 401K to pay down credit card debt last year. I rolled the money into an IRA where I could pay fees upfront to avoid any tax issues.

20

Echoing gotpasswords, review your 401(k) rules to determine if the plan allows hardship withdrawls, and if so, whether you qualify to take a distribution under the plan’s rules. In general, rules regarding hardship withdrawls are strict; taking a withdrawl must usually be your absolute last resort and you cannot have alternate means to avoid a serious financial burden. I don’t believe simple debt repayment qualifies under most hardship withdrawl rules, but again, check with you plan administrator to find out if there’s something that can be worked out.

Avoid taking a regular withdrawl if at all possible; the 10%+ penalty in addition to the regular income taxes is a killer. A debt carried at 4% interest is hardly terrible. Certainly avoid pulling out money just to stuff in a savings account or an IRA (what would be the point? why pay a significant penalty just to move from one retirement account to another?). If you are genuinely worried you’ll be homeless and starving soon due to lack of funds, well, that’s precisely what the hardship withdrawl rules are for.