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Should I cash in my IRAs to pay off debt?
May 3, 2006 7:47 PM   Subscribe

Should I cash in my IRAs to pay off debt? Explanation after the jump...

Here's the situation: I'm 34. I have about 15K in debt as the result of medical expenses and an extended period of reduced income. (I'm embarrassed about it, hence the anon posting.) Now I'm employed, and making headway on the debt (to the tune of about $750/mo). My credit rating is terrific, so that's not a concern, but the interest, and feeling that I'm at huge risk if something unplanned comes up, are both driving me crazy.

I have two IRAs, one Roth and one traditional. The traditional has about 9K in it, and the Roth has about 6K in it. Frankly, both have performed pretty poorly over the years. (In fact, I think the Roth still has less in it than when I stopped contributing to it eight years ago. Oof.)

I know that early withdrawal earns you steep tax penalties, but I can't help but wonder if I would be better off pulling this cash out of these underperforming funds, getting my debt situation under control sooner, and starting fresh.

I'm hoping the collective wisdom here will help point me in the right direction (or point me away from the wrong direction, as the case may be).

One more fact in case it makes a difference: In my new job, I participate in a traditional retirement plan, which should end up socking away about $10K a year. Plus, once I'm out of debt (be it sooner or later), I plan to take a big chunk of the funds currently going towards cc payments and start participating in the TIAA-CREF option available through my employer. (I'll probably put the rest towards an eventual downpayment on a house.)

Thanks for your thoughts and advice.
posted by anonymous to Work & Money (28 answers total) 1 user marked this as a favorite
 
Do not cash out your IRAs. Be patient. Your current pace is terrific, and at this rate you'll be free of your debt in less than two years. Keep up the excellent work, but resist the urge to cash out your IRAs.
posted by jdroth at 7:50 PM on May 3, 2006


Never touch your IRA's. You're making good progress. You can clear off the debt.

Can you pay down the debt at $550 a month instead and put the extra $200 in a bank account? This would allow you to slowly build an emergency fund. I know it would take a little bit longer to pay off your debts, but you'd be safeguarding against future problems.

If you are concerned about the performance of your funds, talk to your financial planner about the mix and your goals. But don't pull out the funds. You'll have taxes, penalties and the like. It's probably going to cost more than the interest on your loan.
posted by acoutu at 7:58 PM on May 3, 2006


You'll get raped at the drive-through if you pull the money out of your traditional IRA, as not only will the withdrawal count as taxable income this year (possibly elevating your tax bracket), but it will actually be taxed, and there'll be a penalty on the earnings too.

It might make sense to pull out your Roth, but it depends on what kind of interest your credit card debt is currently accruing. If you're paying something like 29% interest on your CC debt, definitely pull the Roth and pay down as much of the CC debt as possible. If you're paying under 10% interest on your CC debt, though, it's almost certainly not a good idea. If, as is my guess, you're somewhere in the middle, you should probably get the advice of a competent accountant.

You should also look into putting your IRAs into something stable and relatively low risk - maybe diversify a little bit and aim for steady, non-exciting growth.
posted by ikkyu2 at 8:01 PM on May 3, 2006


Can you pay down the debt at $550 a month instead put the extra $200 in a bank account? This would allow you to slowly build an emergency fund. I know it would take a little bit longer to pay off your debts, but you'd be safeguarding against future problems.

this usually isn't recommended, because the interest on the debt amounts to more than the interest you earn in any rainy day fund. You're better off using all available funds to pay down the debt. In the unlikely event of the emergency, you will still have access to the credit until you close the accounts, and if you have to use it, you will be no worse off than if you had spent your saved cash. In fact, you'll be better off because you have saved on the interrest you otherwise would have paid the cards.
posted by Miko at 8:09 PM on May 3, 2006


As ikkyu2 says, it all depends on the interest rate you're paying on your debt. This is a simple mathematical problem - if the interest you will incur by not paying down your debt now with your IRA is higher that the penalties you will incur as a result of withdrawing your retirement money, it's a no-brainer.
posted by loquax at 8:09 PM on May 3, 2006


Train yourself to never touch the IRAs for anything that's not desperate circumstance. It's your future, not a piggy bank to crack open in the present. Even the draconian new bankruptcy law maintains respect for how inviolable your retirement funds should be. (If you ever get so deep in debt that pulling funds from your IRA seems inevitable, check with a bankruptcy lawyer or tax accountant before doing anything.)

Since you have good credit, how about taking out a personal loan to pay off your current balance? You'll be locking in a much lower rate than whatever the cc is gouging you with.
posted by nakedcodemonkey at 8:18 PM on May 3, 2006


This usually isn't recommended, because the interest on the debt amounts to more than the interest you earn in any rainy day fund.

This is true mathematically, but sometimes it's more important to make decisions that make sense from a psychological perspective than from a mathematical perspective. The poster may pay more money in the long run, but may have greater peace of mind by socking away some savings. I think either approach is fine, and simply depends on the psyche of the person...
posted by jdroth at 8:21 PM on May 3, 2006


I was assuming that you've already consolidated and refinanced your CC debt, but if you haven't, that's certainly the first step to look into.
posted by ikkyu2 at 8:35 PM on May 3, 2006


I don't think Anonymous ever said that it was credit card debt. It's likely that the medical expenses are not.

Whatever part of it is credit card, Anon, you should call up your credit card companies, and ask them for a better rate. You said your credit rating is good now, and you've been making payments, so they should be agreeable. It works, believe it or not. And besides, the worst they can possibly do is say no. You have nothing to lose.

If you can take out a personal loan for the balance of the debt, and the interest rate on the loan is less than the effective interest you'd pay otherwise, then go for it.

Attack your debt with the biggest interest rate first. Make minimum payments on the rest, and send everything you can into that one debt. When that's paid off, take what you were paying and add it to the minimum payment of the next-highest-interest debt. And so forth.

And do not cash out your retirement accounts. You say that in your new job, you can put away $10k/yr, which is pretty good. The way I see it, you have this choice: At the end of a year, you can have either $10,000, or you can have nearly $30,000 saved for retirement.

You'll pay the debt off either way, but one of the two choices won't piss you off when you're 65.
posted by CrayDrygu at 8:45 PM on May 3, 2006


Should I cash in my IRAs to pay off debt?

No.
posted by cribcage at 8:46 PM on May 3, 2006


Making decisions from a psychological perspective is how people get into credit card debt.

This poster seems to be looking for the most expedient way to get out of debt. Putting cash away at an interest rate lower than that which the cards are charging him does not accomplish that goal.
posted by Miko at 8:47 PM on May 3, 2006


Do not cash out your IRAs. Be patient. Your current pace is terrific

Even though the funds are underpreforming, jdroth? I don't mean to derail, but I've been wondering on this subject lately. How can saving in an IRA be a good deal if it keeps losing money?
posted by ThePinkSuperhero at 8:49 PM on May 3, 2006 [1 favorite]


"This is true mathematically, but sometimes it's more important to make decisions that make sense from a psychological perspective than from a mathematical perspective."

Woah, now. That's the kind of thinking that gets people into debt in the first place -- they feel like they can afford stuff, damn the numbers.

I do agree, though, that it's important to have a savings account with a balance that'll pay for anywhere from 3-6 months of living expenses, and that if you're able to create that savings at the same time as paying off a debt, I believe it's important to do so.

There's nothing quite as morale-shattering as incurring new debt while trying to pay off an existing one. If you can maintain a "buffer" savings that'll hold you through an emergency, it's an all-around good idea.
posted by CrayDrygu at 8:51 PM on May 3, 2006


"Even though the funds are underpreforming"

Yes, even though they're underperforming. I'm not sure of the details of how a Roth IRA works, but I'm certain that one of these two options is available:

1) Change the investment options of the fund to something with higher performance, or
2) Transfer the funds into an IRA at a different bank, that will let you pick better performing options
posted by CrayDrygu at 8:53 PM on May 3, 2006


On second thought, I don't apologize for asking my question, because I think it gets to the root of what Anonymous is asking. Especially when one has huge debt, what mathmatical sense does it make it keep money in an underperforming retirement account?
posted by ThePinkSuperhero at 8:58 PM on May 3, 2006 [1 favorite]


Aha, it's not credit card debt - my bad assumption, although I don't think it invalidates anything I said.

I think the Roth still has less in it than when I stopped contributing to it eight years ago. Oof.

This is worse than underperforming. It suggests that the OP would have done better to take this money as cash and put it under his mattress.

The only advantage of a Roth is that it allows money to accumulate earnings tax-deferred. If it's not growing at all, the Roth is *bad* for you, because inflation is steadily eating away at the money you socked away, making it worth less than it was on the day when you worked to earn it.

Now, not only does the OP have money sitting in a Roth, effectively shrinking in present value; but he's also paying his debtholders to service his debt. It doesn't make sense. Unless the Roth can be made to start growing at a rate that earns considerably more than the cost of servicing $6K of his present debt, he's making a mistake.
posted by ikkyu2 at 9:00 PM on May 3, 2006


It's also worth knowing that if you withdraw from your IRA for the purpose of paying medical expenses that cost more than 7.5% of your Adjusted Gross Income, you are exempt from the 10% withdrawal penalty.

You may need to see an accountant about this to see if you can somehow make it work retroactively.
posted by ikkyu2 at 9:06 PM on May 3, 2006


This page covers the details, but it looks like withdrawing the money in an IRA and using it to pay down a debt would incur a 10% fee in addition to income tax that would be taken out of the distribution.

There are a couple of exceptions that might apply, but the $15k in those accounts, withdrawn early, might be more like $11k. So unless the interest rates on the debt are going to cost him more than $4,000, he'd be wiser to re-invest the funds into a better performing IRA.
posted by CrayDrygu at 9:08 PM on May 3, 2006


Sit down with a number cruncher who knows the ins and outs of tax law. Let him tell you whether it makes sense.

For example I've been told to just pay the minimum on my student loans and invest the extra money because I'm paying less interest on the loans than I'm making on the investments. I.e. the dollar is more valuable as an investment dollar than a pay-off dollar.

A good accountant (or financial advisor) should be able to put this in black and white for you.
posted by oddman at 9:28 PM on May 3, 2006


this usually isn't recommended, because the interest on the debt amounts to more than the interest you earn in any rainy day fund. You're better off using all available funds to pay down the debt.

Mathematically, yes. But if you max out your available credit or have a shaky credit rating, it's pretty darn hard to get more credit. If you can't make your minimum monthly payments, you'll be in a heap of trouble. Setting aside 3-6 months of savings can help keep debt from piling up so high that you can never dig out.

In the unlikely event of the emergency

Unlikely event? If you're living on the edge, an emergency may be your dishwasher breaking down, your car needing new brakes, your rent going up, your wisdom teeth needing to be extracted, your job being terminated, your family member becoming ill / having a difficult time and needing you to come visit, your eyeglasses being broken, your wallet being lost, etc. People lose jobs all the time. Stuff happens in life. It becomes an emergency when you don't have an emergency fund.

you will still have access to the credit until you close the accounts, and if you have to use it, you will be no worse off than if you had spent your saved cash.

Unless you have maxed out your credit, have no way to make minimum payments, become psychologically burdened by the stress, etc.

In fact, you'll be better off because you have saved on the interrest you otherwise would have paid the cards.

Unless it takes you years and years to get away from making minimum monthly payments. Unless you slip into depression and can't get a new job. Unless you default on one of your payments and your interest rate goes up further...
posted by acoutu at 9:38 PM on May 3, 2006


It's funny that everyone wants to answer this with platitudes. And if I'm being an asshole, I apologize. But this is an extremely simple exercise.

Get the rate on your debt. Assume an 8% growth rate on your retirement monies. (It's an assumption that I'm sure someone could debate, but it's reasonable.) Find out what you can afford to retire/contribute per month, and add or remove it as necessary. Contrast the two scenarios.

Build a spreadsheet. Remember that premature traditional IRA withdrawals (unless they meet the caveat that ikkyu2 outlined) result in a hit of (.1+your marginal rate) of opportunity cost that you could otherwise apply to your debt. Remember that you'll still pay your marginal rate on the withdrawals when you are 59+ years old.

Run a few scenarios, and make up your own mind.

Or, email matt or jess, and give us the specifics. As it stands now, there is insufficient information to make these calls.

Furthermore, your retirement savings are relatively portable. You can do better than "underperforming funds."

The advice of "never touch your IRA" is wrong. And it's reason #23203472 not to take financial advice from AskMe. It's a decent general rule, but it's not always true. That anyone would give that advice without knowing specifics is disappointing.

Once you put the relevant variables into a suitable model, this becomes a simple exercise. Honestly. Set up the spreadsheet. Feel free to email me if you can't figure out how. I'm qualified and happy to help you.
posted by Kwantsar at 10:07 PM on May 3, 2006


And oddman's advice is fine, but you don't need an accountant. All that you need is a remotely numerate person. The tax situation isn't complicated.
posted by Kwantsar at 10:09 PM on May 3, 2006


If you're IRA and Roth are underperforming, why not change them?
posted by delmoi at 10:50 PM on May 3, 2006


Wow, everyone in this thread is giving you wrong and costly advice. For sure you should cash out your Roth IRA.

You are always free to take out the principle you put into the account. You've already paid taxes on that amount. It's your money. It's only if you start withdrawing more than you put in that you start paying penalties.

In your case it sounds like all of that money is still principle. This is also why it's a good idea to keep financial records around as long as you can. Here is a more authoritative source on the topic. Scroll down for the money quote, "Contributions can be withdrawn tax-free and penalty-free at any time."
posted by euphorb at 10:54 PM on May 3, 2006


I really agree with Kwantsar. The way the question is worded suggests to me that the poster's main issue is the anxiety carrying this debt makes him feel. It is too easy to make bad financial decisions on the basis of feelings. The only antidote is math. I also find the better you really understand your situation and options the more in control you feel.

It should be said to Mr. Anonymous - relax: your debt situation as you describe it is already "under control" (and it's hardly anything to be embarassed about, it's quite average). As far as anxiety about future events - if something unexpected comes up, you can always cash out the IRAs later, but once they go to pay the debt that decision is irreversable. So it's worth taking the decision slowly.

Finally, a couple related things - are you paying too much interest? There's a lot of info out there about seeking lower interest rates and the pitfalls to avoid (balance transfer fees and variable rates, etc.). And another thing Kwantsar is right on about - the money in those IRAs is yours. If the vehicles it is in are not performing, start looking for a new home for it. I did this a few years ago and the change was dramatic - significantly beyond market issues. My money is simply being managed better now.
posted by nanojath at 11:18 PM on May 3, 2006


if you max out your available credit or have a shaky credit rating, it's pretty darn hard to get more credit. If you can't make your minimum monthly payments, you'll be in a heap of trouble. Setting aside 3-6 months of savings can help keep debt from piling up so high that you can never dig out.

You don't need more credit. You have credit accounts already. You're taking the money you would have been saving, and paying into your credit account, reducing your balance, and hence creating available credit in the account. At the same time you're also reducing the amount you pay in interest (which you would not do if your money were sitting in savings) each month, creating more money in your monthly budget.

>>In the unlikely event of the emergency

Unlikely event? If you're living on the edge, an emergency may be your dishwasher breaking down, your car needing new brakes, your rent going up, your wisdom teeth needing to be extracted, your job being terminated, your family member becoming ill / having a difficult time and needing you to come visit, your eyeglasses being broken, your wallet being lost, etc. People lose jobs all the time. Stuff happens in life. It becomes an emergency when you don't have an emergency fund.


You don't have to explain this stuff to me; my understanding of getting out of debt is hard-won. All I will say is that you are better off not setting aside cash beyond a very small amount if you are carrying debt. You also need to be careful what you consider an 'emergency'. Believe it or not, it's possible to wash dishes without a dishwasher. It's possible to work out payment plans with dentists.It's possible to tell a family member you'll come visit them if they can send you some money for the trip. And finally, it's possible to put all these things on your charge card if you absolutely have to...whereas if you use saved cash, each dollar you use is more expensive than it would be if you had been paying down your debt before the emergency struck. Emergencies do happen; but more often than they do, they don't. This is what allows you to get ahead. Make no mistake: if you have debt, paying it down is your single highest financial priority.

>>you will still have access to the credit until you close the accounts, and if you have to use it, you will be no worse off than if you had spent your saved cash.


Unless you have maxed out your credit, have no way to make minimum payments, become psychologically burdened by the stress, etc.

As you pay it down, you increase the available credit. If it's maxed out and you can't pay more than the minimum, again, why do you have money sitting in the bank doing not much? 'Psychologically burdened?'

>>In fact, you'll be better off because you have saved on the interrest you otherwise would have paid the cards.

Unless it takes you years and years to get away from making minimum monthly payments. Unless you slip into depression and can't get a new job. Unless you default on one of your payments and your interest rate goes up further...


If you can't pay more than the minimum, why are you saving money? That money should be going to paying more than the minimum, otherwise you will never get out of debt.

Sorry, acoutu; there's just really no reason at all to set aside cash when you have credit problems -- as long as you have accounts that remain open, the single most important thing to do with any spare money is to reduce the debt. Any other choice hurts you in the long run. It's not an opinion; it's solid cut-and-dried financial advice. Finallly, if you find you can't pay more than the minimum, can't start gaining on the credit, and feel 'psychologically burdened', then your solution is not putting cash in the bank...it's getting a debt-consolidation loan or heading for a credit counseling office ASAP.

Anyway. This is now really OT, since this isn't the OP's problem. Just wanted to call out these common myths. Don't think emotionally about money.
posted by Miko at 7:12 AM on May 4, 2006


You're doing a great job with your debt. Congratulations. Have you negotiated with any hospitals for better terms or some reduction in costs? They vary wildly, but it's worth a shot. I agress that taking principal out of the Roth is not as bad an idea as taking it from a trad. IRA, but I'd be inclined to leave it in.

When the debt is paid off, which will be sooner than you think, really, make sure you take some of that $750 /month and put it into savings, either with maximum IRA contributions, saving for a house, or whatever.

Make sure you have a credit card that's not too ruinous with interest, so you have available money for an emergency. You might want to have a cash cushion of several hundred dollars. I have overdraft protection on my checking account to protect against accidental overdrafts, but also as an emergency cash source.
posted by theora55 at 8:18 AM on May 4, 2006


If you are willing to give up retirement money, then just contribute a little less to your 401k, and put that money toward debt. That way you don't get the penalty bite out of your money. It's great that you have a handle on your debt. You worry about something that might come up. If something happens, and you are no longer able to keep up with the debt, then that is the time to tap the IRAs. Selling off the IRAs should be your very last resort.
posted by fhqwhgads at 8:57 AM on May 4, 2006


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