Pulling From Your Retirement Accounts Should Be Your Last Resort When Paying Debt. What to Do Instead

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U.S. credit card debt declined during the pandemic, as people were generally staying home and spending less money. But as the world ramped up again, revolving debt started increasing throughout the second half of 2021 and the first half of 2022. 

It’s easy to see why credit card spending is up, with a volatile stock market and record high inflation over the past year. Many are wondering what options are available to pay down credit cards.

We spoke with two financial experts on why it’s probably not a good idea to pull from your retirement account to pay off credit card debt, as well as what alternatives you should consider.

Downsides to Pulling From Your Retirement Accounts

Because of the notoriously high interest on credit cards, it’s easy to feel like your balance isn’t shrinking when you’re only making the minimum payment. And while a lump sum payment can be far more effective, it requires money that many people simply don’t have on hand. For that reason, consumers may find themselves turning to the money in their retirement accounts.

Generally speaking, financial experts agree that it’s not wise to pull from your retirement account to pay off debt, even if you have high-interest debt like credit cards.

“Tapping into some retirement accounts early can leave you with a nasty tax bill and often a penalty on top of taxes, which will put you in an even tougher situation if you don’t have the liquidity to pay off the debt without it,” said Lauren Anastasio, a CFP and the Director of Financial Advice at Stash, a financial tech company.

First, assuming the money is in a pre-tax retirement account like a traditional IRA or 401(k) plan, you’ll be on the hook for income taxes for any money you withdraw. Depending on your annual income, the tax rate could range from 10% to 37%, which is excessively steep.

And because the money in your retirement accounts is meant to be used for retirement, there’s an additional 10% penalty on early withdrawals. Between those taxes and penalties, a significant portion of what you withdraw will end up going directly to the IRS.

“Most importantly, it can have a significant impact later in life when you are older, not working, and need to rely on those funds,” said Paramita Pal, the head of US Bankcard at TD Bank.

Once you withdraw the money from your retirement account, you stop your portfolio from growing and compounding to build your retirement account. Unfortunately, you could find yourself with a shortfall during retirement as a result.

Consider this: Withdrawing $10,000 from a retirement account could help you eliminate your credit card debt in one fell swoop. But if you keep that money in your retirement account and don’t add one single more dollar, with a conservative estimate of 8% annual return in the market, it would be worth more than $100,000 after 30 years thanks to compound interest. That’s the beauty of not touching your investments.

Pro Tip

Credit card debt can feel unmanageable, but you may have more options than you think. Consider using a debt snowball or debt avalanche calculator to see just how quickly you could pay off your debt if you allocated your excess disposable income to it each month.

Alternatives to Using Your Retirement Accounts

“It’s understandable that many credit card users want to maintain their credit score and, therefore, may panic during financial hardships if they find themselves in debt,” Pal said. “But instead of tapping their nest egg for funds, I advise looking into alternatives.”

The first option available to tackle your credit card debt is to simply use your excess monthly income to pay off as much as you can. This option won’t have quite the impact of a lump sum payment, but slowly and steadily, your debt will decrease. And using a debt payoff strategy such as the debt snowball or debt avalanche can help you jumpstart the process.

Even if you want to tackle your debt a bit more aggressively, there are still other options available.

“One alternative solution is to seek out credit cards that offer strong balance transfer benefits, such as waiving balance transfer fees or not charging interest on the transferred sum for an extended period,” Pal said.

These credit cards often offer 0% interest for anywhere from 12 to 18 months, meaning all of your payments are going toward your principal balance instead of interest. However, it’s important to make a plan to pay off the debt before the introductory APR ends, or else you risk getting stuck with a high interest rate (and possibly even retroactive interest charges).

Another alternative to using your retirement account is taking out a debt consolidation loan. It’s technically a personal loan, meaning it’s unsecured, just like your credit cards. However, it allows you to pay off several credit cards and consolidate your debt into a single balance and single monthly payment. And often, you can land a lower interest rate.

Bottom Line

While it can be tempting to use the money in your retirement accounts to pay off debt — especially if there’s a large amount in there — experts advise against it. Not only could you find yourself on the hook for significant taxes and penalties, but you’re also robbing your future self, potentially putting your retirement at risk.

As you look for solutions to your credit card debt, it’s also important to address the root cause that got you into your current situation. Sometimes debt is unavoidable, such as in a financial emergency. However, if racking up credit card debt seems to be an ongoing problem, consider creating a budget to decrease your spending to change course.

“Creating a budget and sticking to it is key,” Pal said. “There are many digital tools available to help consumers manage their spending and identify areas where they typically overspend and can cut back.”