Using 401(k) to Pay Off Debt: Is It a Good Idea?

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If you’re wondering whether using your 401(k) to pay off debt is good for you, it depends. You could use your 401(k) to pay off student loan or credit card debt more quickly, but you’re reducing retirement savings while potentially paying penalties. There’s also a chance your 401(k) plan may not even allow the withdrawal.

Using 401(k) to pay off debt: Pros and cons
Cashing out your 401(k): What you need to know
Borrowing from 401(k) to pay off debt
Taking money out of retirement for student loan, credit card debt

Using 401(k) to pay off debt: Pros and cons

You need to consider the pros and cons of using your retirement funds to pay off debt. As you think about what’s best for you, remember that an advantage now could be a disadvantage later in life. Our pros and cons generally focus on your current situation.

Pros Cons
● You could stop adding to your credit card debt.
● You limit your current expenses.
● You get the money now.
● You may not have to pay as much income tax in retirement.
● You could owe a 10% penalty.
● You may start a trend of using your retirement savings as a bank account.
● You could pay income taxes now.
● You could instead transfer your credit card debt to a low-interest or no-interest introductory credit card offer if you have good credit and qualify.
● You’ll lose the power of compounding interest.

Pros

  • You could stop adding to your credit card debt. As of February 2020, the average APR on current credit card accounts that accrue interest is 16.88%, according to CompareCards. By taking money from your 401(k), you limit interest charges on your credit card as long as you stop swiping it regularly.
  • You limit your current expenses. When you no longer have to make credit card or student loan payments, your expenses shrink. Withdrawing from your 401(k) to pay off debt could allow you to manage your budget better.
  • You get the money now. Some people may not be as worried about how much they’ll receive in retirement if they’re going through an urgent financial situation now.
  • You may not have to pay as much income tax in retirement. Your 401(k) contributions are made pre-tax, so you must pay income taxes when you withdraw. If you withdraw early, you could owe less taxes come retirement.

Cons

  • You could owe a 10% penalty. If you’re withdrawing from your 401(k) before your plan’s normal retirement age or you don’t qualify for a hardship distribution, you’ll likely owe an additional 10% on top of what you need.
  • You may start a trend of using your retirement savings as a bank account. Even if paying off debt with your retirement account makes sense now, it starts a slippery slope of withdrawing funds instead of potentially fixing budget issues. The result would be declining retirement savings.
  • You could pay income taxes now. Your tax rate is generally higher during your working years. If you don’t absolutely need the money, you’re likely better off avoiding 401(k) withdrawals to pay off debt.
  • You could instead transfer your credit card debt to a low-interest or no-interest introductory credit card offer if you have good credit and qualify. Ask your issuer about a lower rate or look for introductory balance transfer offers. Introductory offers on these types of cards could extend up to 21 months.
  • You’ll lose the power of compounding interest. One of the purposes of investing long term is that your money and the interest you’ve earned both earn interest. Taking out money from your retirement reduces this power.

Cashing out your 401(k): What you need to know

The first part of cashing out your 401(k) to pay off debt is figuring out how much you have available to withdraw, said Jason Washo, a certified public accountant with Washo Financial in Scottsdale, Ariz. The answer depends on the rules of your 401(k) plan.

For instance, one plan may allow only withdrawals of the money you contributed, while another may allow you to withdraw earnings, Washo said.

No matter which funds your plan allows you to withdraw, there are additional rules. General circumstances where you won’t pay penalties on early withdrawals include, according to Washo:

  • Medical expenses from the same year that are more than 10% of the individual’s adjusted gross income
  • Levies initiated by the IRS
  • Thoroughly documented disabilities that are permanent or life-threatening
  • Divorce orders
  • Adoptions or birth

For adoption or the birth of a child, the withdrawal limit is $5,000 before the 10% penalty applies.

If you’re withdrawing from your 401(k) to pay off debt, you may qualify for a hardship distribution. To do so, the IRS states you need to be in “immediate and heavy financial need.” The exact level of financial difficulty can vary among employers and 401(k) plans. If approved, you still have to pay the 10% early withdrawal penalty, plus income taxes.

Other circumstances for withdrawing funds from your 401(k) with the 10% penalty plus income taxes can include, according to Washo:

  • Medical care expenses
  • Homebuying costs on primary residence
  • Expenses related to higher education, including tuition and room and board
  • Payments to avoid eviction
  • Home repair costs
  • Funeral expenses

For hardship distribution withdrawals, the limit is based on the amount of the expense.

How long does it take to cash out your 401(k)?

“The exact amount of time depends on the individual plan and whether the request is a bank transfer or a check,” Washo said. “Some investments may have minimum holding period requirements, but this would probably be a rare and limited circumstance.”

Borrowing from 401(k) to pay off debt

Getting a 401(k) loan to pay off debt doesn’t require the same approval or have the same penalties as withdrawing funds.

Pros Cons
● You replenish your 401(k) through interest charges.
● You have up to 5 years to repay the loan.
● You won’t pay penalties for early withdrawal.
● You have fewer restrictions when using a 401(k) loan to pay debt than cashing out your 401(k).
● You move debt rather than delete it.
● You may have to pay yourself back faster than with other loans.
● You have to come up with money to repay the debt that you may not have.
● You may owe origination and processing fees.

Pros

  • You replenish your 401(k) through interest charges. Your 401(k) loan payments are designed to recharge your 401(k). You pay interest to lessen the impact of your loan on your retirement savings. You also aren’t subjected to a credit check since you are borrowing from yourself.
  • You have up to five years to repay the loan. This is years longer than you could receive through an introductory balance transfer offer (60 months versus up to 21 months). The exception is if you’re borrowing from your 401(k).
  • You won’t pay penalties for early withdrawal. 401(k) loans are a tax-free withdrawal option.
  • You have fewer restrictions when using a 401(k) loan to pay debt than cashing out your 401(k). You can take out a loan on up to 50% of vested retirement savings or $50,000, whichever is less.

Cons

  • You move debt rather than delete it. Often, working on a plan to pay off debt is smarter, such as by reducing your budget to allow more room for payments, negotiating lower payments or interest rates with your credit card company or getting a forbearance on your federal student loans.
  • You may have to pay yourself back faster than with other loans. Student loans or mortgages may give you up to 30 years to repay debt.
  • You have to come up with money to repay the debt that you may not have. Pay close attention to payment amounts first. You may be better off working with a consolidation company if you can’t afford debt payments.
  • You may owe origination and processing fees. For example, the New York City Deferred Compensation Plan’s 401(k) loan program charges a $50 origination fee and quarterly maintenance fee of $8.75.

Taking money out of retirement for student loan, credit card debt

Student loan debt

If you’re thinking about withdrawing or borrowing from your 401(k) to pay off student loans, you need to carefully analyze various factors.

  • You lose federal student loan protections. Income-driven repayment options can allow you to qualify for a monthly payment of as low as $0.
  • You give up the potential for student loan forgiveness. If you were working toward qualifying for Public Service Loan Forgiveness — 10 years of on-time payments with a public service employer — you’d lose this option if you paid off your student loans with your 401(k) plan.
  • You may qualify for a student loan interest deduction. If you continue paying your student loans as normal, you may be able to deduct interest you paid during the year.
  • You may solve affordability issues. If you’re having trouble making payments because your variable interest rate rose on a private student loan, a 401(k) withdrawal or a 401(k) loan with a lower interest interest rate may give you a boost.
  • You generally can’t discharge students loans in bankruptcy. You would be required to prove your federal or private student loans are causing extreme undue hardship, which is almost impossible to do.

You may decide that you want to pay off your student loans with your retirement plan because you didn’t qualify to refinance your student loans to get a lower interest rate.

Credit card debt

Withdrawing from your 401(k) or using a 401(k) to pay off credit card debt is a completely different decision than whether to use your retirement plan funds to pay off student loans since credit card debt can continuously grow.

According to a 2019 study from Merrill Lynch, 25% of adults ages 18 to 34 have already made a 401(k) withdrawal, with the top reason being to pay credit card debt.

  • Borrowing from your 401(k): You’ll have to repay the money in five years. The new payment could be much higher than a credit card minimum payment, but it could be at a lower interest rate.
  • Withdrawing from your 401(k): This could be a good option in extreme financial circumstances, though it often involves a 10% penalty on top of income taxes.

No matter which route you choose, you could boost your credit score by diligently paying your credit cards on time and lowering credit card balances.

Michelle Argento contributed to this report.

Interested in refinancing student loans?

Here are the top 9 lenders of 2021!
LenderVariable APREligible Degrees 
1.88% – 6.15%1Undergrad
& Graduate

Visit Splash

1.88% – 5.64%2Undergrad
& Graduate

Visit Earnest

2.50% – 6.85%3Undergrad
& Graduate

Visit CommonBond

1.89% – 5.90%4Undergrad
& Graduate

Visit Laurel Road

2.25% – 6.39%5Undergrad
& Graduate

Visit SoFi

1.88% – 5.64%6Undergrad
& Graduate

Visit NaviRefi

1.90% – 5.25%7Undergrad
& Graduate

Visit Lendkey

2.39% – 6.01%Undergrad
& Graduate

Visit Elfi

2.13% – 5.25%8Undergrad
& Graduate

Visit PenFed

Check out the testimonials and our in-depth reviews!
1 Important Disclosures for Splash Financial.

Splash Financial Disclosures

Terms and Conditions apply. Splash reserves the right to modify or discontinue products and benefits at any time without notice. Rates and terms are also subject to change at any time without notice. Offers are subject to credit approval. To qualify, a borrower must be a U.S. citizen or permanent resident in an eligible state and meet applicable underwriting requirements. Not all borrowers receive the lowest rate. Lowest rates are reserved for the highest qualified borrowers. If approved, your actual rate will be within a range of rates and will depend on a variety of factors, including term of loan, a responsible financial history, income and other factors. Refinancing or consolidating private and federal student loans may not be the right decision for everyone. Federal loans carry special benefits not available for loans made through Splash Financial, for example, public service loan forgiveness and economic hardship programs, fee waivers and rebates on the principal, which may not be accessible to you after you refinance. The rates displayed may include a 0.25% autopay discount

The information you provide to us is an inquiry to determine whether we or our lenders can make a loan offer that meets your needs. If we or any of our lending partners has an available loan offer for you, you will be invited to submit a loan application to the lender for its review. We do not guarantee that you will receive any loan offers or that your loan application will be approved. Offers are subject to credit approval and are available only to U.S. citizens or permanent residents who meet applicable underwriting requirements. Not all borrowers will receive the lowest rates, which are available to the most qualified borrowers. Participating lenders, rates and terms are subject to change at any time without notice.

To check the rates and terms you qualify for, Splash Financial conducts a soft credit pull that will not affect your credit score. However, if you choose a product and continue your application, the lender will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and may affect your credit.

Splash Financial and our lending partners reserve the right to modify or discontinue products and benefits at any time without notice. To qualify, a borrower must be a U.S. citizen and meet our lending partner’s underwriting requirements. Lowest rates are reserved for the highest qualified borrowers. This information is current as of June 1, 2021.


2 Rate range above includes optional 0.25% Auto Pay discount. Important Disclosures for Earnest.

Earnest Disclosures

Interest Rate Disclosure

Actual rate and available repayment terms will vary based on your income. Fixed rates range from 2.59% APR to 5.79% APR (excludes 0.25% Auto Pay discount). Variable rates range from 1.88% APR to 5.64% APR (excludes 0.25% Auto Pay discount). For variable rate loans, although the interest rate will vary after you are approved, the interest rate will never exceed 36% (the maximum allowable for these loans). Earnest variable interest rate student loan refinance loans are based on a publicly available index, the one month London Interbank Offered Rate (LIBOR). Your rate will be calculated each month by adding a margin between 2.04% and 5.8% to the one month LIBOR. Earnest rate ranges are current as of 6/8/2021, and are subject to change based on market conditions.

Auto Pay Discount Disclosure

You can take advantage of the Auto Pay interest rate reduction by setting up and maintaining active and automatic ACH withdrawal of your loan payment. The interest rate reduction for Auto Pay will be available only while your loan is enrolled in Auto Pay. Interest rate incentives for utilizing Auto Pay may not be combined with certain private student loan repayment programs that also offer an interest rate reduction. For multi-party loans, only one party may enroll in Auto Pay.

Student Loan Refinancing Loan Cost Examples

These examples provide estimates based on payments beginning immediately upon loan disbursement. Variable APR: A $10,000 loan with a 20-year term (240 monthly payments of $72) and a 5.89% APR would result in a total estimated payment amount of $17,042.39. For a variable loan, after your starting rate is set, your rate will then vary with the market. Fixed APR: A $10,000 loan with a 20-year term (240 monthly payments of $72) and a 6.04% APR would result in a total estimated payment amount of $17,249.77. Your actual repayment terms may vary.Terms and Conditions apply. Visit https://www.earnest. com/terms-of-service, e-mail us at [email protected], or call 888-601-2801 for more information on our student loan refinance product.

Earnest Loans are made by Earnest Operations LLC or One American Bank, Member FDIC. Earnest Operations LLC, NMLS #1204917. 535 Mission St., Suite 1663, San Francisco, CA 94105. California Financing Law License 6054788. Visit earnest.com/licenses for a full list of licensed states. For California residents (Student Loan Refinance Only): Loans will be arranged or made pursuant to a California Financing Law License.

One American Bank, 515 S. Minnesota Ave, Sioux Falls, SD 57104. Earnest loans are serviced by Earnest Operations LLC with support from Navient Solutions LLC (NMLS #212430). One American Bank and Earnest LLC and its subsidiaries are not sponsored by or agencies of the United States of America.

© 2021 Earnest LLC. All rights reserved.


3 Important Disclosures for CommonBond.

CommonBond Disclosures

Offered terms are subject to change and state law restriction. Loans are offered by CommonBond Lending, LLC (NMLS # 1175900), NMLS Consumer Access. If you are approved for a loan, the interest rate offered will depend on your credit profile, your application, the loan term selected and will be within the ranges of rates shown. ‍All Annual Percentage Rates (APRs) displayed assume borrowers enroll in auto pay and account for the 0.25% reduction in interest rate. All variable rates are based on a 1-month LIBOR assumption of 0.15% effective Jan 1, 2021 and may increase after consummation.


4 Important Disclosures for Laurel Road.

Laurel Road Disclosures

All credit products are subject to credit approval.

Laurel Road began originating student loans in 2013 and has since helped thousands of professionals with undergraduate and postgraduate degrees consolidate and refinance more than $4 billion in federal and private school loans. Laurel Road also offers a suite of online graduate school loan products and personal loans that help simplify lending through customized technology and personalized service. In April 2019, Laurel Road was acquired by KeyBank, one of the nation’s largest bank-based financial services companies. Laurel Road is a brand of KeyBank National Association offering online lending products in all 50 U.S. states, Washington, D.C., and Puerto Rico. All loans are provided by KeyBank National Association, a nationally chartered bank. Member FDIC. For more information, visit www.laurelroad.com.

As used throughout these Terms & Conditions, the term “Lender” refers to KeyBank National Association and its affiliates, agents, guaranty insurers, investors, assigns, and successors in interest.

  1. Checking your rate with Laurel Road only requires a soft credit pull, which will not affect your credit score. To proceed with an application, a hard credit pull will be required, which may affect your credit score.
  2. Savings vary based on rate and term of your existing and refinanced loan(s). Refinancing to a longer term may lower your monthly payments, but may also increase the total interest paid over the life of the loan. Refinancing to a shorter term may increase your monthly payments, but may lower the total interest paid over the life of the loan. Review your loan documentation for total cost of your refinanced loan.
  3. After loan disbursement, if a borrower documents a qualifying economic hardship, we may agree in our discretion to allow for full or partial forbearance of payments for one or more 3-month time periods (not to exceed 12 months in the aggregate during the term of your loan), provided that we receive acceptable documentation (including updating documentation) of the nature and expected duration of the borrower’s economic hardship. During any period of forbearance interest will continue to accrue. At the end of the forbearance period, any unpaid accrued interest will be capitalized and be added to the remaining principle amount of the loan.
  4. Automatic Payment (“AutoPay”) Discount: if the borrower chooses to make monthly payments automatically from a bank account, the interest rate will decrease by 0.25% and will increase back if the borrower stops making (or we stop accepting) monthly payments automatically from the borrower’s bank account. The 0.25% AutoPay discount will not reduce the monthly payment; instead, the discount is applied to the principal to help pay the loan down faster.

Assumptions: Repayment examples above assume a loan amount of $10,000 with repayment beginning immediately following disbursement. Repayment examples do not include the 0.25% AutoPay Discount.

Annual Percentage Rate (“APR”): This term represents the actual cost of financing to the borrower over the life of the loan expressed as a yearly rate.

Interest Rate: A simple annual rate that is applied to an unpaid balance.

Variable Rates: The current index for variable rate loans is derived from the one-month London Interbank Offered Rate (“LIBOR”) and changes in the LIBOR index may cause your monthly payment to increase. Borrowers who take out a term of 5, 7, or 10 years will have a maximum interest rate of 9%, those who take out a 15 or 20-year variable loan will have a maximum interest rate of 10%.

KEYBANK NATIONAL ASSOCIATION RESERVES THE RIGHT TO MODIFY OR DISCONTINUE PRODUCTS AND BENEFITS AT ANY TIME WITHOUT NOTICE.

This information is current as of April 29, 2021. Information and rates are subject to change without notice.
 


5 Important Disclosures for SoFi.

SoFi Disclosures

Fixed rates from 2.74% APR to 6.74% APR (with autopay). Variable rates from 2.25% APR to 6.39% APR (with autopay). All variable rates are based on the 1-month LIBOR and may increase after consummation if LIBOR increases; see more at SoFi.com/legal/#1. If approved for a loan your rate will depend on a variety of factors such as your credit profile, your application and your selected loan terms. Your rate will be within the ranges of rates listed above. Lowest rates reserved for the most creditworthy borrowers. SoFi refinance loans are private loans and do not have the same repayment options that the federal loan program offers, or may become available, such as Income Based Repayment or Income Contingent Repayment or PAYE. SoFi loans are originated by SoFi Lending Corp. or an affiliate (dba SoFi), a lender licensed by the Department of Financial Protection and Innovation under the California Financing Law, license #6054612; NMLS #1121636 (www.nmlsconsumeraccess.org). Additional terms and conditions apply; see SoFi.com/eligibility for details. SOFI RESERVES THE RIGHT TO MODIFY OR DISCONTINUE PRODUCTS AND BENEFITS AT ANY TIME WITHOUT NOTICE.


6 Important Disclosures for Navient.

Navient Disclosures

1. NaviRefi loans are made by Earnest Operations LLC, a member of the Navient family of companies, subject to individual approval and underwriting criteria. California residents only: Loans made or arranged pursuant to a California Finance Lenders Law license. Additional terms and conditions apply.

– To qualify, you must be a U.S. citizen or non-citizen permanent resident of the United States, reside in a state we lend in, and satisfy our minimum eligibility criteria. You may find more information on loan eligibility here: https://www.navirefi.com/help-and-questions. Not all applicants will be approved for a loan, and not all applicants will qualify for the lowest rate. Loan terms are subject to eligibility. Approval and interest rate depend on the review of a complete application. Loan approval is subject to confirmation that your debt-to-income, free cash flow, credit history and application information meet the minimum requirements. You must have a minimum FICO score to be considered.

– You can choose between fixed and variable rates. Fixed interest rates are 2.75% – 6.04% APR (2.50% – 5.79% APR with Auto Pay discount). Starting variable interest rates are 2.13% – 5.89% APR (1.88% – 5.64% APR with Auto Pay discount). Variable rates are based on an index, the 30-day Average Secured Overnight Financing Rate (SOFR) plus a margin. Variable rates are reset monthly based on the fluctuation of the index. We do not currently offer variable rate loans in AK, CO, CT, HI, IL, KY, MA, MN, MS, NH, OH, OK, SC, TN, TX, and VA.

– You can take advantage of the 0.25% Auto Pay interest rate reduction by setting up and maintaining active and automatic ACH withdrawal of your loan payment. The interest rate reduction for Auto Pay will be available only while your loan is enrolled in Auto Pay. Interest rate incentives for utilizing Auto Pay may not be combined with certain private student loan repayment programs that also offer an interest rate reduction. NaviRefi rate ranges are current as of June 1, 2021 and are subject to change based on market conditions and borrower eligibility.

– The information provided on this page is updated as of 06/1/2021. Earnest Operations LLC reserves the right to modify or discontinue (in whole or in part) this loan program and its associated services and benefits at any time without notice. Check www.navirefi.com for the most up-to-date information. Terms and Conditions apply. Call 855-284-4893 for more information on our student loan refinance product.

– Earnest Operations LLC – NMLS #1204917, CA CFL #6054788 – 535 Mission St., Suite 1663, San Francisco, CA 94105.
Navient Solutions, LLC – NMLS #212430 – 123 Justison St., Wilmington, DE 19801. Visit https://navirefi.com/lending-licenses for a full list of licensed states.


7 Important Disclosures for LendKey.

LendKey Disclosures

Refinancing via LendKey.com is only available for applicants with qualified private education loans from an eligible institution. Loans that were used for exam preparation classes, including, but not limited to, loans for LSAT, MCAT, GMAT, and GRE preparation, are not eligible for refinancing with a lender via LendKey.com. If you currently have any of these exam preparation loans, you should not include them in an application to refinance your student loans on this website. Applicants must be either U.S. citizens or Permanent Residents in an eligible state to qualify for a loan. Certain membership requirements (including the opening of a share account and any applicable association fees in connection with membership) may apply in the event that an applicant wishes to accept a loan offer from a credit union lender. Lenders participating on LendKey.com reserve the right to modify or discontinue the products, terms, and benefits offered on this website at any time without notice. LendKey Technologies, Inc. is not affiliated with, nor does it  endorse,  any educational institution.

Subject to floor rate and may require the automatic payments be made from a checking or savings account with the lender. The rate reduction will be removed and the rate will be increased by 0.25% upon any cancellation or failed collection attempt of the automatic payment and will be suspended during any period of deferment or forbearance. As a result, during the forbearance or suspension period, and/or if the automatic payment is canceled, any increase will take the form of higher payments. The lowest advertised variable APR is only available for loan terms of  5 years and is reserved for applicants with FICO scores of at least 810.

As of 04/07/2021 student loan refinancing rates range from 1.90% APR – 5.25% Variable APR with AutoPay and 2.95% APR – 7.63% Fixed APR with AutoPay.


8 Important Disclosures for PenFed.

PenFed Disclosures

Annual Percentage Rate (APR) is the cost of credit calculating the interest rate, loan amount, repayment term and the timing of payments. Fixed Rates range from 2.89%-4.78% APR and Variable Rates range from 2.13%-5.25% APR. Both Fixed and Variable Rates will vary based on application terms, level of degree and presence of a co-signer. These rates are subject to additional terms and conditions and rates are subject to change at any time without notice. For Variable Rate student loans, the rate will never exceed 9.00% for 5 year and 8 year loans and 10.00% for 12 and 15 years loans (the maximum allowable for this loan). Minimum variable rate will be 2.00%. These rates are subject to additional terms and conditions, and rates are subject to change at any time without notice. Such changes will only apply to applications taken after the effective date of change.