VISA or pension?

December 15, 2008 1:00 PM

$10,000 available to borrow from a pension plan, and $10,000 in credit card debt.

With the economy tanking and the pension plan currently losing $5-600 per month instead of increasing, is it a wise move to take the loan from the pension plan, pay off the credit cards, and pay the pension plan back with interest each month?

Still 20-25 years away from retirement, if that makes a difference.

posted by An Infinity Of Monkeys to work & money (15 comments total)

Bonus points: On January 15th vesting increases from 40% to 60%. Wait until then and hope the plan doesn't lose another 30%?
posted by An Infinity Of Monkeys at 1:03 PM on December 15, 2008

I don't know the details of your plan, and I can't predict future returns in the stock market. The conventional wisdom, though, is that if possible paying down credit card debt will net more money in the long run than saving for a relatively distant retirement.

One of the key factors is the interest rate on the card, but in general most people don't expect stock market returns to average 9% per year, so if your rate is significantly higher then that you'll probably save money. You would need to look at the consequences of borrowing from your retirement plan, in some cases if you lose your job you may be required to pay it back immediately.

Also, you have to be very confident that you will not just rack up another $10,000 in credit card debt, and be worse off than you were before. The assumption is that you'll be paying what you would have paid on the card back into your retirement fund, so it's not an excuse to keep spending more than you can afford.

Wait until then and hope the plan doesn't lose another 30%?

Do you have any options for directing your investments in your plan? If you're only planning on holding the money for a short period of time for a specific purpose, you'd probably be better off moving it from a stock market fund to a money market fund or cash, if those are available.
posted by burnmp3s at 1:19 PM on December 15, 2008

It might, depending on the interest rate on your credit card. You probably shouldn't do it unless you are prepare to cut up your credit card and not put any more debt on it.

Nobody knows when the stock market will recover. It could be one month or it could be one or two years. But if you are out of the market you could miss the upturn.

There is another serious risk. If you lose your job or quit to take another job, you must immediately pay back any balance owed to your pension plan. If you can't come up with the money on short notice, you will be required to pay taxes and a 10% early withdrawal penalty on the balance. This could be more than a third of your balance, gone forever.
posted by JackFlash at 1:20 PM on December 15, 2008

"Do you have any options for directing your investments in your plan?

Limited to a subset of four different-risk/return mixes which were chosen by the plan administrator. No money market or cash options.

"You probably shouldn't do it unless you are prepare to cut up your credit card and not put any more debt on it."

That would be the plan, yes.
posted by An Infinity Of Monkeys at 1:28 PM on December 15, 2008

Cashing out now is a bit of a coinflip as to whether you're saving additional pain or not, IMO.

We're at 860 now, a price seen on the upside on June 11, 1997.

600 next year is entirely possible, but IMHO you should be a (DCA) buyer at these prices not a seller.

Here's a chart of the 2002-2003 market movement, where we cycled around 850 for a while.

I'm no expert so the fact that M3 is $14T+ now and was $7T in 2002 has me somewhat perplexed by these declines. I guess we as a nation threw too much income into chasing real estate and not into productive capital and now the debt overhang is killing us like Japan in the 90s.

Whenever I'm confronted by these decisions I like to go HALFWAY. Pull $5000 out and pay the credit card down. That way whichever way the market goes you've made the not-worse decision.
posted by troy at 1:35 PM on December 15, 2008 [1 favorite has favorites]

Go ahead. You'll be paying yourself the interest. I'm not sure how these loans work, but if they actually take it out of your account you'll be paying it back, and re- buying your stocks at the current (lower) prices.
posted by Gungho at 1:59 PM on December 15, 2008

Most plans require loans to be paid back in full if you either leave your job or are laid-off. Do be mindful of that in your planning - it'd be horrible for you to end up worse off than when you started.

If you assume that you will absolutely will lose money in your plan in the near future, you should immediately stop investing in it regardless of what you want to do. However, is that really an accurate assumption? If you know how the market is going to act, you can become a very quick millionaire by shorting stocks appropriately.

The previous paragraph was sarcastic. The question is actually a lot simpler than you think. If your expected gain for the market is greater than your credit card interest rate, it makes no sense to pay off your credit card debt - you're making more money in the market. If the cost of the load minus the expected market losses is less than your credit card interest rate, it makes no sense to stay in the market - you'll make more money paying off your credit card. Notice that the loan "interest" is not figured in the equation - it just entices you to put back more money into your plan. If you have more money to put in your plan, you should do so regardless.
posted by saeculorum at 2:14 PM on December 15, 2008

Before you do that, examine your budget very carefully, track your spending, and find where else you might be wasting money you could be dedicating to the credit card debt payoff. Cutting off cable for a while, or no eating out, or a frugal holiday might serve you better in the long run.
posted by Riverine at 3:07 PM on December 15, 2008

Most 401(k) plans allow you to take a loan of something like 50% of the cash value of your plan. Taking the loan does not imply that you are selling off any of the holdings of the account. You are simply taking a loan using your retirement account as collateral. (This is why you can only borrow 50%. The value can fluctuate, and if you have to liquidate the account to pay off the loan, you will have to pay taxes and penalty on your withdrawal.) Less an administrative fee, the interest goes into your account. As others have noted, if you leave the company's employ, you will probably have to pay off the loan immediately, which will probably mean liquidating some of your holdings and taking the tax and penalty hit.

If it's not a 401(k), then I'd check with your plan administrator to make sure of the rules, but they are probably similar.

Even if you lose your job and end up having to liquidate part of your retirement account to pay off the loan, it may not necessarily be a bad deal, depending on your company's matching. If your company matches 10% of your contributions, and you are vested, then that would offset the penalty you would pay in the event of a withdrawal. Being unemployed with no debt is a better position to be in than being unemployed with $10,000 of credit card debt. The downside is that it would put you a good year behind in contributions, and assuming you are contributing the maximum, you can't really "catch up" later. So you would need to be comfortable with the fact that you will have significantly less (maybe as much a $50,000 to $100,000 less) at retirement. Of course, if you're not maxing it out, you could do so and catch up over the following few years. Or if you don't have a Roth IRA yet (and don't make enough to be ineligible) you could start one of those and contribute to it for a few years.

Another option is to contact a credit counselor and have them negotiate to lower your interest rates on your credit card. They may be able to get you a rate as low as zero, as well as getting some penalties waived if you have those. This will look bad on your credit report for a few years, so I wouldn't advise it if you are planning any big-ticket purchases (car, house) in the near future, and it could put you in kind of a bind if you need new credit for an emergency. However, it will definitely enforce credit discipline, because they'll close your accounts and you won't be able to get any more for a while.
posted by kindall at 5:11 PM on December 15, 2008

kindall, this is a 100% employer money purchase plan. The company contributes an amount equal to 15% of salary up to $30K, then 10% of everything above. I contribute nothing.

Does that make a difference?
posted by An Infinity Of Monkeys at 7:30 PM on December 15, 2008

kindall: Taking the loan does not imply that you are selling off any of the holdings of the account.

This is not true of any 401(k) loan plan I am aware of. When you take the loan, the amount is deducted from the holdings within your account. Some plans deduct a pro-rated amount from each fund in your account. Others require you to transfer the loan amount into a cash holding before it it withdrawn. Others simply deduct from the most conservative holding. So in that sense, it is less like a loan against collateral and more like a temporary withdrawal. If this were not true, then the company or plan provider would be forwarding you an interest free loan and it would make sense for everyone to take the loan and put it in a money market account. Obviously this is not the case, nor could most companies have the funds to provide interest free loans. There is no free lunch. You have to sell holdings to get a loan.

Even if you lose your job and end up having to liquidate part of your retirement account to pay off the loan, it may not necessarily be a bad deal, depending on your company's matching. If your company matches 10% of your contributions, and you are vested, then that would offset the penalty you would pay in the event of a withdrawal.

This is not true either. Assume you take the loan and pay off the credit card. Then you get laid off. Within 90 days you must pay back the loan. If you can't find the money to pay off the loan, it is considered a permanent early withdrawal. In that case you are then responsible for paying the full income taxes for the amount of the loan plus a 10% penalty. This money will be due with your regular income tax. Either way you are going to have to come up with a pile of money from someplace. And whether or not your company matches, it is still money lost. The matching is irrelevant.
posted by JackFlash at 8:46 PM on December 15, 2008

After more checking, I see that some plans will allow you to take a loan by merely signing a promissory note without liquidating funds in your account, but these plans seem to be rare. You have to read your Summary Plan Description for the loan details.
posted by JackFlash at 9:08 PM on December 15, 2008

Monkeys, here's the deal.

The whole thing hinges on whether or not you are in a position to get a handle on your credit card debt right now - to stop carrying debt, stop carrying a balance from month to month ever for any reason, and devote a certain extra amount of money every month to paying off your pension loan, while still remaining so solvent that you will never need to carry a credit card balance at all for any reason in future.

Nothing else matters in terms of answering your question. Only this.

If you can do that, yes, it's a good idea to take this loan and use it to pay off the credit card debt. If you cannot do that with 100% certainty, it's a bad idea. Here's why.

Let's look at the CC company as your enemy. They want all your money and all your future earnings. They'd like to take that away from you while providing as little to you as possible. Their wet dream is where you are maxed out - meaning that they never need lay out any more money to a vendor (like amazon.com, for instance) because of you - while, at the same time, you have to pay them money, principal plus a high rate of interest.

Now when you run up all that debt, they can come after you with collections. But they can't touch your retirement money. They can never get their hands on it. Even if you declare personal bankruptcy and all your assets are liquidated to pay your creditors, you still don't have to give up your retirement money. That's protected and can not be made available to your creditors. Also, if you declare bankruptcy, your credit card debt is wiped out, because it's unsecured debt. Your CC company knows this.

If you take this loan and use it to pay down your CC bill, and then a year from now you owe your CC company another $10,000 that you've run up, they've *won*. They've beaten the laws designed to protect you. They've gotten $10K out of your retirement accounts - that's your money, no matter where it came from, don't forget that - into their pocket, something they never could have done on their own no matter how powerful the lawyers and collections agencies at their disposal.

On the other hand if the situation that caused you to run up $10K in debt is gone, over, done with, and you can confidently assert that you can pay all your expenses plus a new monthly loan payment just out of income for the foreseeable, your plan's a good idea, because it results in your paying interest to yourself instead of the CC company. You get to keep that interest, minus some fees. You win.

Clear?
posted by ikkyu2 at 9:44 PM on December 15, 2008 [6 favorites has favorites]

The 401(k) plans I've had have all had loans of the promissory note type. If you have to actually liquidate some of your investments to take out a loan, I wouldn't do it. Remember, you traded your dollars for shares of stock or other equities in your retirement account. The exchange rate back to dollars is highly unfavorable right now. You would have to be paying a lot of interest on a credit card to make it worthwhile to cash out equities at what is probably a huge loss.
posted by kindall at 11:34 PM on December 15, 2008

ikkyu2, that makes perfect sense and is in fact how I was looking at it. The credit card debt that will be retired was for a once-in-a-lifetime purchase so that will be the one and only time it gets used.

Thank you to everyone for your thoughtful answers.
posted by An Infinity Of Monkeys at 7:01 AM on December 16, 2008