Just to expound on this, given the following assumptions:
Thanks for all of the suggestions!
To answer some of the questions and assumptions:
-I currently do NOT have cable, only Internet and Netflix, Internet being essential to my business and Netflix at $7.95/month wouldn’t really help me or hurt me either way.
-I do own a car that is paid off, but would be silly to sell for something different (Prius that gets 50MPG)
My current business has averaged 35% growth per year so I’m currently leaning towards the suggestion of growing my business and using cash flow to pay down the debt.
However I am sick of throwing almost $200 a month at these cards,so I may bite the bullet and take out a loan with my IRA as collateral.
Sorry, that’s not an option. IRS rules prohibit assigning IRA finds as collateral. From here:
One can take a loan from a 401k, but not an IRA.
Just one question: assuming
Would that be more or less than the value of the IRA above?
I’m NOT saying it’s a good idea to withdraw from the IRA, for all kinds of psychological reasons. I’m saying that, strictly on the finance end, the debt goes up much much much faster than the IRA would, so – assuming complete rationality – it’s a no-brainer to withdraw from the IRA paying single digit interest, in order to pay off the credit cards at 22%. Again, I think the best strategy is to do anything possible to get a loan at a better rate than the 22% (use the car as collateral?), but straight rational financially, the IRA withdrawal makes sense.
Are you not allowed to borrow from an IRA the way you can with a 401(k)?
NO! What with taxes (Fed & State) and penalties you’ll lose half of your IRA.
Tax bite is almost always lower, and in many states, you pay a penalty to them, also.
Assuming no payments, you would still be paying 22% on the piece of the debt that the withdrawal didn’t cover. Factor that in.
You are not allowed to borrow form an IRA the way you can with a 401(k).
There is a provision in the law that allows you to return a distribution taken from an IRA within 60 days once in every 365 day period. The purpose is to facilitate transfers from one custodian to another and some abuse this provision and call it a 60-day “loan.” There was a disturbing ruling from a bankruptcy court judge a year or two ago in a case that obviously involved a person who was blatantly abusing the 60-day provision. The court held that the person had invalidated their IRA. The ruling was later affirmed by the 11th Circuit.
As far as 401(k) loans go: That is an option that a 401(k) may offer. Your 401(k) does not have to offer it. So be sure to check your plan documents to see whether loans are available. It is a very popular feature, so it probably is. But don’t assume without checking.
This assumes the OP never replaces the funds from the IRA. Let’s say OP takes the loan and pays off the card, then replaces the funds in the IRA over the next 12 months. Then the real cost would be the difference between the potential growth of the $5000 over 40 years vs over 39 years. Not that I think the OP should do that. I think he/she would be better off transferring the balance to a low interest card, focus on paying it off, and leave the IRA alone.
Notice that he said this was a SIMPLE IRA. The penalty for a withdrawal from a SIMPLE IRA in the first two years is 25% (in addition to the income tax owed on the withdrawal). The 10% penalty is increased to 25% in the first two years.
No, I did not notice that. In that case, the penalty is too high to be offset by the savings in interest of the credit cards.
No, the ‘replacement’ would be an addition if the origiinal money had not been withdrawn. Your scenario would only apply if the OP’s intent was to leave his contribution at $5,000 for the life of the IRA. If the intent was to add to the account over time, the withdrawn money is “lost” forever.
To answer your question as written, under your given assumptions, the debt would be MUCH less than the value of the IRA after 40 years. In fact, the debt would have been long since written off, the statute of limitations for collection passed and any blemish removed from the credit report. IOW, the debt would be zero.
The real point is that one cannot compare future value of a short term debt to future value of an asset since they are completely different things.
From a purely arithmetic perspective yeah, but you have to have the discipline to repay yourself.
Not to mention, the 10% plus taxes is money that is gone forever, and you lose the growth on your money.
If the OP can manage the cc payments now, plus perhaps a bit extra every month, I’d personally be more inclined to do that. Once you’ve withdrawn the IRA money you can’t put it back, but you can always change your mind and withdraw it later if you decide that’s a better option.
Another alternative: can you get some other kind of loan from a bank or credit union that would have a lower rate than the credit card?
A hypothetical, assuming my Excel skillz are mad enough:
If you owe, say, 12,000 dollars, you’d need to withdraw 16,000 from the IRA to cover the 12K - 25% of 16K is 4,000. and that 4,000 is gone forever.
If you pay that credit card at 500 a month, your interest at 25% is going to add up to 2,600 dollars at the end of a year and your principal will be down to 8,600. At the end of 2 years you’ve paid 4300 in interest and you still owe 4300.
If you pay 600 a month, after 2 years you’ve paid 3600 in interest and you’re down to 1200 on the card.
AND, you still have the 16,000 in the IRA at that point.
Do some comparisons to see what your money would grow to if you wiped out the credit card debt and paid that 600 into your IRA (assuming that doesn’t exceed any limits) with a reasonable growth rate of, say, 5%.
Also look into what the withdrawal would do to your taxes. You may be paying roughly 15% income tax right now (Federal, don’t forget state if appropriate) but by increasing your income another 16,000 that year some of that might get bumped up into the next bracket (20% or whatever). Play around with the numbers in TurboTax or something to do some what-ifs before you do anything irrevocable.
Me, I treat the IRAs etc. as sacred. We had a family emergency last year (parents were being foreclosed) and we had to tap a 401(k) loan to take care of them, and I hate it and am counting the months until it’s paid off (3.5 more years, sigh).
You have to count the penalty as if it were interest - it’s a cost of taking that money out. The 25% penalty, plus income tax, is higher than the interest on the credit card if I’m following the numbers correctly.
You can do something about the credit card interest (pay it faster, take a lower-rate loan elsewhere). Once that money is out of the IRA though the penalty and taxes are gone and you can’t do anything about them.
Versus the 22.6% interest he will pay on the $4500 credit card balance while paying it back over 30 months at $200. $1409 if I am not correct.
I have already stipulated the penalty is 25%, not 10%, however.
True - I saw the 25% figure after I posted. So the loss on that 5,000 dollars is more like 40% (25% penalty plus, say, 15% in taxes) - so you’d only get 3,000 dollars for paying down the credit card.
That would leave a credit card balance of 1,500, and nothing in the IRA. Without crunching all the numbers (including assumptions re growth of the 5,000) it’s hard to tell which is better in the short and long term. To me though, there’s a very important psychological benefit to leaving the IRA money untouched - that should be a last resort when you can’t pay it down any other way.
If the OP is paying 200 toward the credit card, he’d have to pay 8 more months to deal with the remaining 1,500 dollars versus, say, 25 months to pay down the 4,500 balance.
If he were to take the IRA money, then put the 200 back into the IRA starting with the 9th month, that’s 17 months (25 - 8 = 17) of paying 200 into the IRA. That means he’d have saved up 3,400 dollars - putting him 1,600 less than the current IRA balance.
That’s all mental arithmetic, I may have guessed wrong on the length of time to pay 4,500 at 200 a month for example, but it suggests that given what we know, tapping the IRA is not likely the best option.