This question was posted in our HTM Facebook group by an anonymous member…
“My husband and I have some credit card debt. We are considering a loan from our 401K because the interest we pay is going back to us-to our account. We are about 8 years from retirement and on track with savings/investments. Any concerns with this?”
The short answer:
We’re always hesitant when people talk about borrowing or withdrawing 401k funds early – no matter the reason why.
That’s because there are usually other (less harmful) options that can be pursued first.
In some cases though, if the amount is small, and the timeframe is short, then it might make sense to borrow from your 401k to get you out of a quick financial bind.
Here are some things to consider…
Getting a 401k loan
Thanks to the Secure 2.0 Act, It’s actually easier than ever to tap your 401k for quick cash.
Anyone can make ‘hardship withdrawals’ of $1,000 without any specific justification. It’s like stealing candy from a baby (except you’re actually stealing it from your future self!)
Just because it’s easy to get that money doesn’t mean you should do it.
401k loans aren’t the worst thing in the world. But folks need to be very careful before taking the plunge. Why? Because there could be some harsh consequences if it’s not handled properly.
The main risk is that if you lose (or leave) your job before you’re done paying back those funds, the full amount of the loan must be paid back immediately.
If you can’t pay that loan back, it will be considered a “withdrawal”, which means mega taxes and penalties. Ouch!
Another downside is that you forfeit any market returns, because the money you’re borrowing isn’t invested during the loan period, which sucks.
Other options to consider
One avenue you could try is calling your credit card company and asking for an interest rate reduction. They might do it just because you asked!
That might sound far fetched, but it really does work for many. Because the credit card company wants to keep you as a paying customer vs. you moving the debt elsewhere or paying the balance off.
Getting a new 0% balance transfer card likely makes more sense too. But that also depends on your level of discipline and timeline for getting that debt paid off.
Some balance transfer cards will give you ~18 months of 0% interest. They do charge a fee (typically ~3% of the balance), but that can be far less than the compounding interest.
Will 18 months be long enough to pay off that balance organically? Balance transfer cards really only make sense if you can FULLY pay that debt off during the no-interest period.
Other options to crush that debt are to take drastic measures to either a) reduce your monthly expenses, or b) make more money somehow.
We know it’s tough to make lifestyle cut-backs. But dropping to a bare bones budget is only needed for a short period of time. You’d be surprised at how much you can save if you put your mind to it!
And making extra money these days is easier than ever! Gig economy jobs can be picked up overnight. They pay out fast too.
So those are the things we’d recommend exploring first before taking out a 401k loan to pay off that credit card debt.
Staying out of credit card debt
An underlying issue we need to bring up… What got you into this cc debt in the first place?
You mentioned being on track for retirement which is awesome. Congrats!
It’s just really important to make sure you don’t fall into the same debt trap down the road, especially if you take a 401k loan or use a balance transfer credit card. These are strategies that should only be used once.
If you don’t have the discipline to pay everything off and stay out of debt, you’ll wind up in a worse financial position.
So once you’ve decided the route you want to take, the next step is to reflect on all your habits. Make a few tweaks to your routine, track your expenses, and be mindful of every purchase.
The Bottom Line:
While getting a 401k loan seems nice because you’re paying yourself interest, there are a few risks and downsides that shouldn’t be overlooked.
The biggest risk is this becoming a recurring habit, and treating your 401k like a piggy bank to tap into every time you get into credit card trouble. It’s a slippery slope!
That’s why we recommend either side hustling for a short period of time to make extra cash and pay off that debt in short order. Or massively reducing your cost of living for a little while to save extra money.
Feeling the pain short-term will actually work wonders long term. It’ll snap you out of any bad habits and prevent you from getting into credit card debt again in the future!
For the full version of this discussion, check out Podcast Episode #793 (it’s the last question in the episode)
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