How to Pay Off Debt Using a 401k
If you have significant debt that is compromising your ability to secure financing for major purchases, such as an automobile or a new home, it might be possible for you to borrow against your 401k to reduce your debtload. This can work to your advantage, because 401k loans are not normally reported to credit bureaus, whereas outstanding debt negatively affects your credit rating.
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Instructions
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Approach your employer about the possibility of getting a loan against the money in your 401k rather than simply withdrawing from the plan. This way, you can avoid the Internal Revenue Service's taxing penalties for accessing your account before you've reached the standard age of 59 1/2. Employers with loan programs in place will usually lend the money at an interest rate commensurate with the interest the money is earning while tied into the 401k.
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Talk to your 401k administrator about accessing your Summary Plan Description (SPD). Here, the terms under which you are permitted to withdraw money in your 401k account early will be laid out. Generally, you must be facing significant financial hardship to qualify for early access to your 401k money.
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Withdraw only as much as you need to pay off your debt if, in fact, you do qualify to withdraw from your retirement savings plan. If you are under the age of 59 1/2, you will normally be facing a 10 percent penalty on the amount of the deduction, in addition to standard income tax rates on the amount of money you take out. While there are ways to avoid these penalties, they require you to draw the money out in annual installments, which will generally not be helpful to people looking to pay off debt month by month.
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Use the money you get from your 401k plan to promptly eliminate your outstanding debt. Manage future debt responsibly to improve your credit rating, so that you can avoid having to tap into your 401k again in the future.
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Establish a long-term plan to replenish the money you withdrew from your 401k, if you took money directly from the plan. If you borrowed from your employer, you will normally have your wages garnished to refund the loan amount. While using your 401k to reduce debt isn't normally an advisable practice, you can prevent long-term damage to your financial stability by replacing what you took.
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Tips & Warnings
Spend some time crunching the numbers carefully. Speaking long-term, using your 401k to pay off debt usually costs more than simply buckling down and reducing your debtload month by month using your employment or other income.
