Q. I'm considering taking a loan from my vested 401(k) plan at work to pay off my credit card debt of $6,000. The APR (annual percentage rate) on my card is high at 17% and I'd love to get rid of it. I'm in my early 30s so I figure I have plenty of time to make up the difference. Is this a wise move?
A. As tempting as it might be to borrow from your 401(k) to wipe out your high interest debt, it's best to consider your retirement account off limits. Raiding your 401(k) can be hazardous to your wealth! If you end up losing your job or leave your employer before a 401(k) loan is paid off, the balance must typically be repaid right away. If you can't pay it (and are younger than age 59½), the outstanding amount is considered an early withdrawal, subject to ordinary income tax plus a 10% penalty. That hurts!
The purpose of a retirement account is to fund your retirement. So even if you think your job is rock solid, consider these alternative ways to deal with your debt:
Get a low-interest personal loan from a local credit union or a peer to peer lending site like lendingclub.com.
Apply for a low-interest credit card that allows you to transfer your high-interest balance.
Set an aggressive goal to stop using the card and to eliminate your debt. I crunched the numbers: You can wipe out your debt by paying $300 a month, or $70 a week, for two years.
For more about taking loans from a 401(k), be sure to read or listen to Money Girl episode number 191.
401(k) Egg image courtesy of Shutterstock