If you’re currently facing a mound of credit card debt, you might be eyeing that bright, shiny retirement account of yours as a way to pay it off. After all, the money’s just sitting there, taunting you with its so-close-yet-so-far funds. But attempting to cash in your retirement money to pay off your credit card bills is a bad idea. You’re better off creating a budget or using a debt payoff method, like the debt snowball, instead. This article will cover the top 3 reasons not to use your retirement account to pay off credit card debt.
Different types of retirement accounts
Before we dive into the reasons that using your retirement account is a bad way to pay off credit card debt, let’s go over three of the main types of retirement accounts:
- Traditional IRA: You contribute to a traditional individual retirement account (IRA) with pre-tax dollars. Earnings and contributions get taxed upon distribution.
- Roth IRA: With a Roth IRA, your earnings and contributions are contributed with after-tax dollars, meaning they’re distributed tax-free.
- 401(k): A 401(k) is a plan that’s sponsored by your employer. You can automatically contribute funds from your paycheck into your retirement account, and your employer may offer a matched contribution up to a certain percentage.
Why you shouldn’t use your retirement account to pay off credit card debt
Here are 3 reasons why you shouldn’t use your retirement account to pay off your credit card debt.
- You’ll face taxes and penalties: Funds in your retirement account are meant to stay there for a long period of time. If you want to access funds from your IRA/401(k) plan before you’re 59 ½, you can expect to be penalized by way of penalties (such as a 10% early withdrawal fee) and taxes. With a Roth account, you can withdraw contributions, though if you want to withdraw earnings you may need to pay penalties and taxes depending on a number of factors, such as how long you’ve had the account.
Though there are some exceptions to the early withdrawal penalty for traditional IRAs/401(k)s, such as death and disability, you’ll still have to pay income taxes on your withdrawal.
- You’ll lose out on compound interest: Ah, compound interest. A magical financial principle that causes your money to grow more the longer it’s invested. If you take out your retirement money to pay for your credit card bills, your future earnings will take a hit. For example, let’s say you have $30,000 in your retirement account that you want to use for your credit payments. If we estimate an annual return of 5%, this money will grow to $129,658.27 in 30 years. It’s the ultimate marshmallow test: Would you prefer $30k now (before factoring in taxes and penalties), or an extra $99,658.27 in the future?
- Future-you might need the money more: When you’re young, healthy, and gainfully employed, your finances (hopefully) aren’t a life-or-death matter. Spending too much on mimosas at brunch? Curb your spending or get a side hustle for a little extra cash. But when you’re older, not working, and more likely to be dealing with health issues, that money can take on a whole new level of importance.
Better ways to pay off credit card debt
Here are a few other ways you can pay off your credit card debt.
- Create a budget: Creating and sticking to a budget can help you better manage your money and avoid discretionary expenses that could be contributing to your debt. To make a budget, compare your post-tax income against your monthly expenses. If you notice you’re spending more than you’re saving, it’s time to tweak your budget and cut out items you don’t actually need.
- Select a debt payoff method: Debt payoff methods, like the debt snowball and debt avalanche methods, can give you a payoff blueprint to follow. With the debt snowball method, you’ll make minimum payments on all of your balances, but you’ll put extra toward the smallest one. Once that’s paid off, you’ll put extra toward the next smallest balance. The debt snowball method is great for those who need a little extra motivation. The debt avalanche strategy focuses on paying off debts in order of largest to smallest interest rates. You’ll still make minimum payments, but you’ll put extra money toward your balance with the highest interest rate. Once that’s paid off, extra will go to the next highest interest rate. The debt avalanche method can help you save more money overall since you’ll pay less in interest.
- Using a balance transfer: With a balance transfer, you’ll move your existing credit card balances to a new card with a lower interest rate than what you’re currently paying. Balance transfers can both simplify bill paying (you’re only paying one bill per month) and save you in interest.
Your retirement account might be whispering sweet nothings into your ear, but it’s best to leave it untouched for now. Try one of the other debt repayment strategies and leave that IRA or 401(k) to grow into the effective savings vehicle you know it can become. Your future self will thank you big time.
By Stefanie Gordon
Stefanie Gordon is a content strategist with over a decade of professional writing experience. She is a former financial journalist who has spent the last several years working in digital marketing. She specializes in content strategy and creation for large and small businesses in finance and technology.