But trying to cash in your retirement money to repay your credit card bills is a terrible idea. You are better off creating funding or a debt payoff method, such as the debt snowball. This guide will cover the top 3 reasons not to use your retirement accounts to pay off credit card debt.
Various Kinds of retirement accounts
Before we dive into the motives that using your retirement accounts is a wrong way to repay credit card debt, let us discuss three of the main types of retirement accounts:
- Traditional IRA: You contribute to a traditional individual retirement account (IRA) with pre-tax dollars. Earnings and contributions get charged upon distribution.
- Roth IRA: With a Roth IRA, your earnings and contributions are provided with after-tax dollars, implying they’re distributed tax-free.
- 401(k): A 401(k) is a plan that your employer sponsors. You can automatically contribute funds from your paycheck into your retirement account, and your organization may offer a matched contribution up to a defined percentage.
Why you shouldn’t use your retirement accounts to pay off credit card debt
Here are three reasons you need to use your retirement accounts to pay off your credit card debt.
You will confront taxes and penalties: Money on your retirement accounts is supposed to remain there for a long time. If you would like to access funds from the IRA/401(k) plan before you are 59 1/2, you can expect to be penalized utilizing penalties (like a 10% early withdrawal fee) and taxes. Using a Roth account, you can withdraw contributions, although if you would like to withdraw earnings, you might want to pay penalties and taxes based on various factors, like how long you have had the account.
Even though there are a few exceptions to the early-withdrawal penalty for conventional IRAs/401(k)s, such as death and disability, you will still have to pay income taxes on your withdrawal.
You will miss out on compound interest: Ah, chemical interest. A magical financial principle which causes your money to grow more the longer it is invested. Should you take out your retirement money to cover your credit card bills, your future earnings will take a hit. By way of instance, let’s say you have $30,000 in your retirement accounts that you wish to use for your credit payments. If we estimate an annual return of 5 percent, this money will grow to $129,658.27 in 30 years. It’s the most significant marshmallow test: Can you prefer $30k currently (before factoring in taxes and penalties) or an additional $99,658.27 later on?
Future-you may need the cash more: When you are young, healthy, and gainfully employed, your financing (hopefully) is not a life-or-death issue. Curb your spending or receive a side hustle to get a little more cash. However, when you’re older, not functioning, and more likely to be dealing with health problems, that cash can take on a completely different level of importance.
Here are a few different ways you can pay off your credit card debt.
Produce funding: Creating and sticking to a budget can help you better manage your money and steer actual discretionary expenses contributing to your debt. To make a budget, compare your post-tax income from your monthly expenditures. If you see you are spending more than you are saving, it is time to tweak your budget and cut out things you do not need.
Select a debt payoff method: Debt payoff techniques, such as the debt snowball and debt avalanche procedures, can provide you a payoff blueprint to follow. Together with the debt snowball method, you will make minimum payments on all your balances, but you are going to put extra toward the smallest one. Once that is paid off, you’re put extra toward the next smallest balance. The debt snowball system is fantastic for people who need a little more motivation. You will still make minimum payments, but you will put additional cash toward your balance with the maximum interest rate. Once that’s repaid, extra will go to the next highest rate of interest.
Employing a balance transfer: Using a balance transfer, you will move your current credit card balances to a new card with a lower interest rate than what you’re presently paying. Balance transfers can simplify bill paying (you are only paying one bill a month) and save you in interest.
Your retirement account may be whispering sweet nothings into your ear, but it is better to leave it untouched for now. Try one of the additional debt repayment plans and make that IRA or 401(k) grow into the successful savings vehicle you know it can become.
From Rohit Kumar
Rohit Kumar is a content strategist with more than four years of professional writing experience. He’s a former financial journalist who has spent the past several years working in digital marketing. He specializes in content strategy and production for large and smaller businesses in technology and finance.