If you have one or more credit card balances with a high interest rate, you may feel as though you will never be able to pay it off. If you have accumulated a significant amount of money in a retirement account, you may be tempted to withdraw some or all of it to reduce or wipe out your credit card debt. That would be a bad idea.
An Early Withdrawal May Cost You Taxes and Penalties
You may have to pay taxes on any money that you withdraw from a retirement account. With a traditional IRA or 401(k), contributions are made with pre-tax dollars. If you have one of those accounts and you make a withdrawal, you will have to pay federal taxes, and possibly also state taxes. You won’t have to pay taxes if you withdraw money from a Roth IRA or a Roth 401(k) because contributions to those types of accounts are made with after-tax dollars.
A retirement account is meant to let money grow over time so you can withdraw funds when you’re no longer working full-time. If you withdraw money before the age of 59 1/2, you may have to pay a penalty. Rules depend on the type of account, how long you have had the account open and the reason for the withdrawal.
You Will Lose the Benefit of Compound Interest
If you use your retirement savings to pay off credit card debt, you may lose tens of thousands of dollars because retirement accounts grow through compound interest. Money that you contribute earns interest, and then you earn interest on your original contribution, plus the interest that it earned. If that process continues over a period of decades, it can help you accumulate a sizable nest egg for retirement.
If you withdraw money from your IRA or 401(k) to pay off credit card bills, you will lose the benefit of compounding and you may not have enough time to build your account balance back up before you plan to retire. That means you may struggle to support yourself in retirement or have to keep working longer than you would like.
Look for Another Way to Manage Your Debt
If you’re feeling overwhelmed by credit card debt, tapping into your retirement account should be a last resort. Explore other options, such as a balance transfer credit card with a lower interest rate or a debt consolidation loan. If you contact your creditors directly and explain your circumstances, they may be willing to lower your interest rate or work with you to create a payment plan.
