How to Use Your 401(k) to Pay Off Credit Card Debt
A 401(k) is a retirement plan sponsored and maintained by your employer. You are allowed to borrow money against your 401(k) plan, usually for a lower rate of interest than you would pay on a credit card. A typical 401(k) loan repayment plan is limited to five years unless you use the money for a home down payment, in which case it can be extended to 10 years. Although there is no credit check required, you are borrowing your own money and limiting the growth of your retirement nest egg.
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Instructions
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Determine how much money you are eligible to borrow from your 401(k). As of October 2009, the rules are that you can borrow up to 50 percent of the value of your 401(k) plan or $50,000, whichever is less. For example, if your 401(k) plan is worth $80,000, you could borrow up to $40,000 but if your 401(k) plan is worth $100,000 or more you are limited to $50,000.
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Contact your employer's benefits department to apply for a loan against your 401(k) plan. The loan will usually be processed within a week or two.
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Pay off your credit cards with the funds from the loan, eliminating or reducing your high-interest credit card debt. The amount of money you save will be based on the spread between the rate for the credit cards and the rate for the 401(k) loan.
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Repay the loan as quickly as possible so that your retirement savings can continue to grow. Some companies do not allow you to make additional contributions to your 401(k) plan until you have repaid the loan, so if you take the full five years to repay not only do you lose the interest you would have earned during those years but you also lose five years of additional 401(k) contributions.
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Tips & Warnings
By taking a loan from your 401(k) plan rather than making an early withdrawal, you avoid paying the 10 percent additional penalty on the loan.
If you leave your job or are fired before your loan is repaid you must usually make a lump sum payment within two months of leaving or the outstanding money will be considered an early distribution and you will have to pay taxes as well as the 10 percent penalty for early withdrawal.
