Paying Off Debt with Retirement Savings - Is it the Right Thing to Do?

 

Using retirement money to pay off debt is a very serious decision. Surely, in the long term, high-interest debt will be avoided if you pay off such debt. 

However, you must consider that doing this will sacrifice the potential for future investment gains inside your retirement account.

Furthermore, these early withdrawals may mean added taxes and penalties that can further decrease the amount you have available for use toward your debt and further deplete your retirement savings.

Pros and cons of using retirement savings to repay debt

Using retirement savings to pay off debt is one major decision that could have an impact on an individual's long-term financial future.

Here are some considerations to help make a decision as to whether it is a prudent move:

Pros of Using Retirement Savings to Pay Off Debt

Immediate Debt Relief
Paying off high-interest debt, like credit card debt, offers a chance to provide immediate financial relief by reducing overall interest payments.

Improved Cash Flow
Removing debt payments can alleviate cash flow each month, which could help make one's daily expenses more manageable and eliminate the stress of making those payments.

Possible Interest Savings
If the interest rate for that debt is considerably higher than what you are earning on your retirement savings, over time, you could save a lot just by paying off the debt.

Cons of Using Retirement Funds to Pay Off Debt

Tax Penalties and Fees
You'll have to pay taxes and early withdrawal penalties, such as for those younger than 59½ years, which grossly cuts down the amount available to pay the debt.

Lost Growth of Investments
Your retirement savings are invested to increase over time, compounded. If you withdraw money, you reduce the amount that has a chance to keep growing, which may hurt your long-term financial security.

Less Security in Your Retirement
Depleting retirement savings will undoubtedly compromise your future financial security since you cannot afford to retire comfortably or have to work longer.

Opportunity Costs
It is money that is paid out for debt service that will no longer be available to take advantage of any other investment opportunities with better return potential over time.

When is it good to pay off debt with retirement savings?

Generally speaking, using retirement money to pay off debt is a lousy idea; however, based on your financial condition, there may be a couple of scenarios in which it does make sense. Here are a few instances:

• If you're approaching retirement, the emotional and financial burdens from the debt alone are enormous.
• If your high-interest debt is growing faster than your retirement account,
• If you can quickly pay off the aggregate debt without it making a significant dent in your retirement account,
• In the long term, keeping retirement funds will benefit you more than you would achieve by relieving your debt burden immediately.

How to Avoid Using Retirement Funds

Debt Consolidation
Consider debt consolidation, which combines high-interest debts into a single payment plan with a lower interest rate, reducing monthly payments and interest costs.

Balance transfer
Only some credit cards offer introductory interest rates of 0% on debt-to-transfers. This way, one can at least be relieved from high-interest debt in the short term. 

However, to avoid excessively higher interest rates, it is very important that the remaining amount be paid off before the promotional period ends.

Adjustments to Budget
Go through your budget and make adjustments, finding areas where you can cut back on spending and then apply those savings toward debt repayment.

Credit Counseling
Look for credit counseling to help you find other ways of managing debt and come up with a plan that best fits your financial situation.

Increase Income
Find ways of increasing your income by picking up a side job or selling some stuff that is lying around but doesn't serve a useful purpose anymore. This would surely help pay off those debts quicker.

Negotiate with Creditors
Contact your creditors to see if there is an opportunity for a reduction in the interest rates or other terms of the debt.

Key Considerations

Withdrawal Taxes
Unless your retirement distributions come from a Roth 401(k) or Roth IRA, you are going to be liable for paying income taxes. Your withdrawal will be taxed by the IRS 10%–37%, depending on your income tax bracket. 

Therefore, in order to withdraw enough to meet your duty, you need to project how much tax you will owe in advance. Again, the exception is a Roth retirement account. 

With a Roth 401(k), you do not pay income tax on withdrawals of contributions or earnings.

Penalties on Early Withdrawals
Anyone who cashes out early faces severe financial penalties. The IRS considers the early withdrawal as income, and hence income is taxable. 

In addition, you will be required to add a further 10% as a penalty for borrowing against the loan if you are less than 59.5 years old, unless you are able to prove that you are in an extraordinary situation of the kind mentioned above.

Due to this, you will end up losing 32% of your early withdrawal to the IRS if you fall into the 22% tax bracket.

This means that, in order to pay off $10,000 in debt, you'd have to withdraw around $14,500 from your retirement account. Do be aware that you'll have a 10% penalty on withdrawals from early Roth 401(k) accounts, although you won't have to pay income tax.

Conclusion

While retirement savings are an easy means of paying off debt objectively speaking, this alternative often comes with a big price. 

Carefully weigh the pros and cons, consider alternative strategies, and maybe consult a financial advisor to make an informed decision that will help you realize your long-term goals.

Author Bio:

Attorney Loretta Kilday has over 36 years of litigation and transactional experience, specializing in business, collection, and family law. She frequently writes on various financial and legal matters. She is a graduate of DePaul University with a Juris Doctor degree and a spokesperson for Debt Consolidation Care (DebtCC) online debt relief forum. Please contact her on LinkedIn for further information.

Lucrative Investments To Generate Retirement Funds

Retirement is just along the horizon, and you can’t wait to clock out of work one last time. When planning to retire, you must consider your lifestyle and how you plan to spend your time. 

Thinking about your budgeting and income is important, whether you intend to travel every month or live a low-profile retirement life.

A popular way to make extra money is by exploring different types of investments. While each type of investment has risks, they can also be profitable. 

Here are a few lucrative investments to generate retirement funds and help you make the best financial decisions.

Individual Stocks

While purchasing individual stocks is risky, it can also be rewarding. Investing in stocks requires extensive research and understanding. 

That’s because when one invests in stock, they own a piece of the company. That said, many factors can go into the efficiency of a single stock, including time, experience, and your needs. 

However, when you own single stocks, you control what you sell. This is a major plus for those who want full control over their funds and ownership.

Rehab Loans or FHA 203(k)

Have you ever thought of flipping fixer-upper homes? Another great way to gain funds for retirement is to dabble in the real estate industry. FHA 203(k) loans allow you to add the property’s purchase price and renovation expenses into one mortgage. 

This is a great investment opportunity for those who want to redefine neighborhoods and diversify their property portfolio. Before searching for properties, research the housing market and what rehab investors should expect for the remainder of 2023.

Individual Retirement Accounts (IRA)

Individual retirement accounts (IRAs) are another lucrative investment opportunity to generate retirement funds. IRAs are long-term savings accounts for those with earned income, including those with a 401(k). 

However, IRAs limit how much you can contribute to your account annually. The current limit is $6,500 and $7,500 if you’re over 50. There are various types of IRAs to fit your financial needs, such as traditional IRAS, Roth IRAs, and SIMPLE IRAs.

Final Thoughts

Relax comfortably in your retirement years by making smart investments. The good news is that you don’t have to be a millionaire to invest in lucrative funds. 

Contact a reputable financial advisor to help you make the best financial decisions and set yourself up for success. Remember, with detailed planning and research, you can score big!

The Dos and Don’ts of Cashing in Your Retirement Funds

The age of 65 is significant for many of us; it can signal it’s finally time for retirement or time to sign up for Medicare vs traditional health care insurance. But what are the rules about withdrawing money from your retirement funds when the time comes?

With the elation that comes with retirement, and the opportunity to start a new chapter in life, it can be easy to forget that retirement funds are finite. Yes, you’ve been dutifully paying into your accounts for years, but it’s important not to stay mindful of your spending habits.

Resist These Temptations in Retirement

Did you know that if you withdraw money from your retirement account before you reach age 60, the funds will be subjected to a 10% penalty in addition to income tax? However, there are some ways you can navigate early withdrawal without the 10% fee tacked on.

Ways to Avoid Early Withdrawal Penalty

• Wait until age 59 ½ to withdraw money from your IRA
• Use the money for medical expenses that exceed 7.5% of your adjusted gross income
• If you’re unemployed, early withdrawals can be made to pay for insurance premiums
• After 12 weeks of unemployment, penalty-free withdrawals can be approved
• Early withdrawals can avoid the penalty if used for education (room and board, textbooks)
• An individual can avoid the 10% fee when up to $10,000 is withdrawn early to build/purchase a first home
• Up to $5,000 can be withdrawn after the birth or adoption of a child
• Military service exemptions
• Inherited IRAs are only subject to income tax, not a penalty fee, for early withdrawal

Obviously, it’s ideal if you can avoid dipping into your retirement early, but life sometimes throws unexpected surprises at us!

Treating Retirement Like a Windfall

If you’ve resisted the temptation to withdraw money from your retirement funds early, the next tip is to avoid treating your retirement money like an unexpected financial windfall. Yes, you’ve planned for this season of life, but you should still budget responsibility so the money lasts. 

It can be tempting to indulge in splurges such as gambling or new cars when you retire. Better use of your retirement might be to invest in yourself, your relationships, or ventures with the potential for future earnings.

There’s nothing wrong with treating yourself in your retirement, but remember that a car loses value as soon as you drive it off the lot, so if you need or want to upgrade after you retire, do so wisely. 

If you want to travel and spend money on your hobbies, do so responsibly. If you want to help out family members financially, consider setting up repayment plans and treat the financial support as a personal loan vs a gift.

Waiting Until 65 to Enroll in Medicare

Did you know that you need to enroll in Medicare before your 65th birthday? This is an oversight many people make due to myriad reasons. Often, if an individual is still working at age 65, they have insurance through their employer. 

In this case, they are eligible to enroll in Medicare after turning 65. It’s when a person is not currently employed that they run the risk of paying a penalty for enrolling in Medicare late.




To avoid paying a higher monthly premium for Medicare, be sure you know the window of time during which you need to apply. Even if you have supplemental coverage between the time of retirement and your 65th birthday, start the transition to Medicare. 

If you’re already claiming your Social Security benefits prior to turning 65, you should automatically receive notice from Medicare about coverage when you turn 65.

How to Enroll in Medicare

If you’re not already receiving Social Security benefits before your benchmark, 65th birthday, you will need to take the reigns of enrolling in Medicare. 

Since many people are not accessing SS benefits until age 67, it’s important to contact Social Security regarding Medicare during the enrollment window, which is typically the span of three months before the month you turn 65, and three months after you turn 65. 

This seven-month period has different deadlines for different types of coverage, so it’s best to contact Social Security in the three months leading up to your birthday to avoid any lapses.

If you’re not sure how or when to enroll in Medicare, and what coverage you need, there are services such as MedicareCU, which partners with credit unions to offer education about Medicare.

The Dos of Retirement Spending

We’ve talked about what to avoid, now let’s focus on what you should do with your retirement money.

Invest in Yourself

We mentioned before that you deserve to spend your retirement money on yourself and your loved ones. After all, you’ve spent decades working toward your Golden Years, and now it’s time to enjoy them!

Education

No matter what formal learning you already have under your belt, it’s important to continue learning after retirement. You now have the time to dive deeper into your hobbies and interests, so take classes for your favorite language, to learn more about technology, or how to grow the garden you’ve always dreamed of.

Exercise

Investing in your health is always money well-spent. In retirement, be sure you’re staying active not just for your physical health, but your mental health as well. 

Participating in group fitness classes, taking solo walks, or lifting weights at the gym is not only good for you but good for your wallet. Regular exercise can help prevent costly health expenses in the future.

Experiences

If you’re not used to having the freedom to do what you want once you retire, you may find yourself feeling aimless or depressed. Use your time and savings to experience the things you didn’t have time for when you were working full-time. 

Travel to visit family and friends, purchase a membership to a museum, or get season tickets for your local sports team. Having trips, exhibits, and games on your calendar can help you find a new schedule to live by that offers a sense of purpose and fulfillment.

No matter how you decide to spend your retirement, or when you access it, seek financial advice from a trusted advisor to avoid fees and overspending. 

If you’d rather keep track of your budgeting yourself, there are retirement calculators and apps readily available, or you can simply call your credit union or bank for updates on your account balances.