EagleTribune.com, North Andover, MA

Business

December 1, 2012

Cashing 401 (k) to repay loan a dumb idea

Is it a good idea for a married couple in their early 30s, who have a lot of student loan debt, to cash out one of their 401(k)s to pay it off?

No way! You never cash out a 401(k) or IRA to pay off debt, unless it’s to avoid a foreclosure or bankruptcy.

Let’s say you take $50,000 out of your 401(k). Do you know what happens next? They’re going to charge you a 10 percent penalty, plus your tax rate. If you make $75,000 a year, that puts you in a 25 percent tax rate, plus the penalty. That’s a 35 percent hit, and that’s how much of your money is going straight down the toilet.

Look at it this way. You wouldn’t ask me if it’s OK to borrow money at a 35 percent interest rate to pay off your school loans, right? That would be ridiculous, and this is just as dumb.

There are no shortcuts when it comes to getting out of debt.

Roll up your sleeves and get on a beans and rice budget where every dollar has a name. This will enable you to save money and pay off that debt.

My wife and I have our fully funded emergency fund in place, and we’re debt-free, except for the house. She wants to return to school to get a master’s degree and change careers. She’ll be reimbursed up to $7,000 a year. Can we use some of our emergency fund to get things started?

I’ve got a better idea. Save up the money!

You guys are in great shape already. And to me, this opportunity seems like a small investment with a fabulous return. I really like the idea. But you have to be careful when it comes to things like this. You don’t want to get into the habit of calling things emergencies when they’re not emergencies. It’s a great thing, but it’s nowhere near an emergency.

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