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Making sense of paying of CC debt with a 401k (like) distribution

Hello:

I am married, in my late 40's and own a house (combined income 100K) so I have the usual tax deductions (we are DINK's).

I also have no financial "horse sense" so bear with me here.

I am about to receive around $90k from an in service distribution from my ESOP (Same tax rules as a 401k plan or IRA with 10% penalty etc). I have opened a Traditional IRA account at my bank to roll it over to.

I have $13000.00 in cc debt that I would like to pay off by withdrawing this amount from my new account.

I understand that I would pay a 10% penalty plus the extra income tax hit BUT once those cards are paid off my cash flow will increase by $300.00 a month (since I wouldn't have cc payments anymore). I like the idea of being out of debt so that is why this appeals to me even though it doesn't seem to make much sense from a financial standpoint.

What would be a better way to handle the CC debt? Should I use my equity line instead and avoid the early distribution and be able to write off the interest? However I would still be stuck with monthly payments.

Here are some additonal thoughts and theories:

I will be able to shelter some of this tax hit this year since I also enrolled in a FSA account and maxed the contributions this year to $3000.00 (yes I will be spending that on health care--I haven't been to a dentist in 6 years ;-) plus other qualified expenses). so my AGI will be reduced somewhat.

Would I be allowed to contribute $5000.00 into that IRA in 2008 and write that off as well (thus reducing my AGI) or is that not allowed? As I do work full time, in theory wouldn't this contribution be considered valid for tax purposes as it is derived from earned income?

Or is my logic flawed here?

Thanks for any advice.

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Reply to
Noemail
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I fully respect the satisfied feeling of "being out of debt", but it's not always the best thing to do. I get the impression that your brain and your heart are conflicting on this decision. Please take a moment to look at our outside points of view.

Assuming you are in the 25% tax bracket, you will need about $20k to pay-off that $13k in credit card debt using your proposed method. That stings. It will take a long time to put that back into your retirement account. I don't consider this method as paying off debt, but rather trading it for a larger debt in the future (by having $20k compounded dollars less to retire on).

Another alternative: you can use your HEL which not only lowers the interest rate paid on your debt but also makes that interest deductible. Just as importantly, it leaves that $20k in your IRA to grow at a rate that is hopefully higher than the interest rate you are paying. The increased discretionary cash flow can be used to pay down the HEL faster or to boost your savings. Either are viable options dependent on your risk preferences. A drawback to this plan is that the HEL is secured debt and failure to repay could result in foreclosure. The probability of this occurring is unknown.

**All of the above assumes that your HEL has a favorable interest rate, your tax scenario is as I assumed, and that you can earn a positive net return on your investments. These assumptions may or may not be accurate.

Good luck in your decision making.

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Reply to
kastnna

What is preventing you from making payments greater than $300 per month so that you could pay this off quickly out of regular income?

Elizabeth Richardson

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Reply to
Elizabeth Richardson

It also assumes that they will not turn around and run up the credit cards again. Most people do. -- Doug

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Reply to
Douglas Johnson

The rules for this are fairly staight forward as many people in my company have also done this so to answer your question yes I have checked it out. What it is is called an "in service distribution" where I can elect to withdraw 10% of my fund every 10 years. Plus at

55 I could (if I quit the company) start taking the rest of my money out over a 3 year period and again roll it over to the IRA until I was 59.5.

Now I probably won't do that, but the point is I still will have around $900k at that point so it's not like I'm cashing out my entire retirement nest egg right now.

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Reply to
Noemail

Well, we have 2 car payments and a mortgage and the wife also has CC debt (not as much as myself though; about $6000.00) plus we like to do things in our lives that cost money (Vacations entertainment etc). But I understand about living within our means though--I just don't practice what other's preach though.

I should have also stated initially that we have been married for less than a year now so there is a period of adjustment one goes through when combining incomes. As she earns more than I do, it's kind of a balancing act when it comes to our individual debt from before we were married. We do split all joint bills though, but the CC debt from our former single lives should be our own responsibilty and I don't really think it's fair for her to pay my old debt; so that is why I would like to get back on track.

But yeah, I realize it's probably a dumb thing to do but I like the feeling of a clean slate debt wise. The trick is to not get back on that merry-go-round once I get off of it (if I do decide to do it)

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Reply to
Noemail

Why would that be a better deal than sheltering the distribution and taking the tax hit?

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Reply to
Noemail

$900k will provide about $36K per year (given the 4% rule we discuss here). I trust that's just 'your' account? In which case you may be on track for a good level of replacement income. JOE

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Reply to
joetaxpayer

Well, it sounds to me like you simply want less of the debt you have so that you can go into debt on something different. This doesn't make good financial sense.

Elizabeth Richardson

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Reply to
Elizabeth Richardson

I lost track of what you're doing but I think I have it now...you'd rollover 10% of your ESOP to an IRA, then take an early distribution from the IRA of an amount adequate to pay off the credit cards?

Forget that whole thing for a moment...there are some special tax rules on ESOP stock that you can use when you (eventually) take a full distribution, either at retirement or when you leave the job. You can rollover to an IRA then, but it might not be the best move. The reason is that taxes and penalties are based on the cost basis in your ESOP stock, not the value at time of distribution. If your stock has very low cost basis, you might want to make use of these rules when you leave the company. So taking money out now could, in the long run, be a waste of a big tax benefit that you're sitting on.

One comment on your basic question...if you have $900k in a 401k (or is this all ESOP?) and are running up credit card debt, it's worth revisiting your 401k contribution rate. There is a such thing as saving too much for retirement. But that's a "going-forward" issue...you typically end up paying so much tax on early 401k/IRA distributions that they're an expensive source of cash. A cheaper solution may be to halt all 401k contributions and pay off the debt. And of course, if you're overspending your income, cut back on that.

-Tad

PS for info on ESOP tax rules google NET UNREALIZED APPRECIATION

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Reply to
Tad Borek

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