If you have plenty of debt, you might be tempted to do everything you can to pay it off at once, especially if it has a high interest rate. However, before you use your retirement accounts, you should understand the pros and cons. There are also a few other options to consider.
Options for Debt Repayment
It’s always best to look into all the options so you don’t have to use your retirement funds to pay off your loans. You should avoid touching your retirement accounts until you have exhausted all the other options. Think about assets you have that you may no longer need. For example, perhaps you have a life insurance policy you no longer need. You could consider selling that for cash. You can use a life settlement calculator to see how much the policy is worth. That can help you better plan out the options open to you.
Understanding Retirement Accounts
Even if you have a high interest rate on your debt, it’s never a good idea to dip into your retirement savings. Even if you are at risk of having it sold to a collector, consider all your options before pulling from retirement. It’s a good idea to first understand the different account types. Roth accounts are funded using after-tax dollars, and you can take contributions without paying taxes. However, a 401(k) account is funded using before-tax dollars, as well as funds from an employer.
On the other hand, an IRA account is not sponsored by an employer. Instead, you open it and put in the funds yourself. You can choose from both Roth and traditional options. No matter what kind of account you have, you most likely will not be able to take out funds before you are 59 and a half. And early withdrawals can lead to much less interest being earned on the funds in the future. You might be affecting your ability to retire at your desired time.
If you take out funds from your accounts early, you will need to pay taxes on them. If you are taking them out of a traditional tax account, you will need to pay your regular income tax rate, and this could increase your total taxable income, putting you into a higher tax bracket for the year. However, if it is a Roth account, you will not need to pay taxes, as you already have. Besides taxes, you also need to think about the potential penalties. The funds are meant to stay in your account for a long time, so you will most likely need to pay a penalty if you take the money out before you are 59 and a half years old.
Of course, there are a few exceptions to this rule. For example, you can often withdraw money from your Roth account without penalty if you are taking out your contributions. You will likely need to pay taxes or penalties if you are taking earnings out. The amount of time you have had your account and distribution’s purpose will determine exactly what happens. You might want to speak with an accountant to learn what an early distribution might mean for you.