People who use retirement funds to pay off debts can end up deeper in debt than they were before they withdrew money from their retirement accounts. One problem is that people who feel pressed to get out of debt don't consider whether they have enough cash in retirement accounts to change their debt situation.
Deep in Debt
Some people are too deep in debt to use retirement funds to pay off loans and credit cards effectively. A 2011 MSN Money article titled "Are You Foolish to Pay Your Bills?" notes that some people pay debts with retirement funds in an attempt to avoid bankruptcy or a home foreclosure. Yet many ultimately declare bankruptcy or lose their homes because they don't have enough in their retirement accounts to pay off their debts. They even accumulate more debt from taxes they must pay on the funds they withdrew from their accounts.
Repayment Plan
List all of the funds you have available to dig yourself out of debt, including retirement funds. The MSN Money article recommends that people make a plan to pay off credit cards, personal loans and other consumer debts if they can pay off those debts in five years or less. Otherwise, bankruptcy may be the only option. Creditors involved in bankruptcy filings usually can't confiscate people's retirement funds. Therefore, you may needlessly lose your retirement nest egg if you choose to cash out your retirement account and later declare bankruptcy.
401(k) Accounts
Workers usually can borrow up to $50,000 from their 401(k) accounts. A Motley Fool article titled "9 Ways to Pay Off Debt" says borrowers essentially repay themselves with interest because payments on their 401(k) loans go back into their accounts along with the interest charges. However, account holders must repay their loans within five years, and the loan limit of $50,000 may be too small to solve some people's debt problems.
Considerations
People who choose to borrow from their 401(k) accounts to pay their debts must immediately pay off the amount borrowed if they leave their jobs. Otherwise, they can be required to pay taxes and penalty fees, which gives them more debt to pay. According to the MSN Money article, people can lose as much as $100,000 in future income each time they take $10,000 out of their retirement funds to pay debts.
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