How to Avoid Tapping Into Your 401k to Pay Off Debts

When you invest in a 401k plan, it is not wise to access your funds before retirement. Though you can withdraw your money for a specified list of emergencies (pay off college fees, avoid eviction from your house, medical expenses and disability expenses), it invites a premature withdrawal penalty of 10 percent. Here are a few steps to help you avoid tapping into your 401k specifically to pay off debts.

Difficulty: Moderately Easy

Instructions

1. Plan wisely. Maintain your reserves independent of your 401k investment. This will enable you to meet an unforeseen turn of events. Remember, 401k is strictly a retirement plan.

2. Get a loan on your 401k plan. This will help you avoid a premature withdrawal penalty and you can pay back the amount with interest. You can withdraw up to half of your invested money but not more than $50,000.

3. Borrow from your 401k only when you have no other choice. When you take such a loan, you have to pay your income tax on the borrowed amount. Once you've paid back the loan, you will have to pay your income tax again on the collective amount when you retire. Effectively, you will have to pay an income tax twice on the same amount. Secondly, if you lose your job midway through the repayment, the loan will be due immediately. Failure to repay it will invite the premature withdrawal penalty and taxes.

4. Use a home loan for buying a new house and use a student loan (or preferably a scholarship) for your child's tuition fees and college expenses. Many people use funds from their 401k for these two types of debts.

Tips & Warnings

• Avoid tapping into your 401k for credit card and other debts. Even though you can use the funds for certain expenses as mentioned above, it is always recommended not to withdraw your investment in a 401k for any kind of debt.