Paying off debt is a top priority for many people since debt can be a serious issue that leads to financial instability, reduced access to essential resources, and even bankruptcy. But is using your retirement savings the best way to go about it? Here are a few things you should consider first when deciding to pay off debt or save for retirement:
How much debt do you have?
Debt can be an enormous financial burden, and it can be challenging to get out of debt. To help you figure out how much debt you have, it's essential to know your credit score and what your monthly payments cost. You can also use a debt calculator to see how much debt you could pay off in a certain amount of time. If you're to the point that you feel the only other option is bankruptcy, then it might be better just to take the hit on your retirement account and use those funds to pay off your outstanding debt. However, this should only be done when you're out of other options and have a significant amount of debt that you can't pay off by any other means.
What is the interest rate on your debt?
The interest rate on your debt is the amount you'll pay each month for the privilege of borrowing money. It's important to know this figure because it can affect how much money you'll end up paying in total. There are ways you can lower your interest rate that doesn't involve sacrificing your retirement fund, like debt consolidation loans. However, you first need to know what your rates are so you can shop around for a better deal that doesn't require tapping into your 401(k).
What are the penalties of withdrawing from your retirement fund early?
There are a few potential penalties for withdrawing money from your retirement fund early. The most common penalty is a tax bill. If you're under 59½ years old and you withdraw more than $10,000 from your retirement account in a single year, you'll have to pay a 10% early withdrawal penalty on the amount you withdraw. The penalty increases to 25% if you're over 59 and a half-years-old and the withdrawal is made for a purpose other than retirement, such as paying off debt.
What is the expected lifespan of your retirement fund?
Retirement funds are typically invested in stocks, bonds, and other securities that may have a long or short lifespan. The expected lifespan of a retirement fund generally is around 10 to 20 years but could be as short as five years or as long as 50 years, depending on how much is invested and the way your funds are diversified. Taking money out of a retirement fund to pay off debt may shorten the lifespan of the retirement fund and could lead to a reduced retirement income which could be a big problem when you're out of the workforce and living on a fixed income.
The bottom line
In most cases, it is better to leave your retirement savings untouched and focus on paying off your debt. However, your financial situation is unique, and only you will know the best thing to do. Weigh the costs and benefits from this article to help you decide which route to take.
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Original Source: Credello: Should You Take Money Out of Your Retirement Fund to Pay Off Debt?
