I love to get questions from people about personal finance issues. And today I got a great one. A friend asked me, Should I pay off my car loan using my 401(k)?
My friend is getting pretty serious about wanting to get out of debt. When people start getting serious about getting out of debt, they start trying to find any way they can to pay off debt. One asset that people see is a big pile of money sitting in their 401(k). But, is it a good idea to pay off debt using a 401(k)?
You might have wondered about this question yourself. I think we all think wouldn't it be nice to pay off credit card debt or pay of car loans in one easy payment by withdrawing money from our retirement accounts.
But, this is a terrible idea for two reason - (1) you will have less money for retirement and (2) you will be giving your money to the government (I give enough money to Uncle Sam).
You need to save for retirement!!
While it would be nice to get out of debt quickly using 401(k) money, creating a habit of using retirement money to clean up your bad spending habits is a terrible idea. Don't rob Peter to pay Paul.
Don't Pay Penalties and Taxes Associated With Withdrawing Money From 401(k)!!
The price for withdrawing money from a 401(k) is way too high to use it to pay down debt. You will be socked with an immediate 10% penalty and will immediately have to pay taxes on the amount of money you withdrawl. That means that you will immediately lose 30%-50% of the amount of money you withdrawl to pay off your car loan or whatever other loan you want to pay off.
But, How Should I Get Out Of Debt?
People hate paying off debt because it does not happen overnight. We want instant gratification, but getting out of debt does not happen that way.
However, it is surprising how fast you can pay off debt if you set your mind to it. One thing that I always suggest for people who want to get out of debt is to get a second job. Earning more money is the best way to pay off debt fast.
So, please don't rob from your retirement 401(k) to pay off a car loan. There are other ways to pay off your car loan. Start thinking about second jobs that you would not mind doing.
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