401k: Cash out to pay credit card debt?

[neatdesign]

The second half of last year was not good for us financially. Not good at all. Bottom line is, we got into a load of credit card debt. About $28,000 worth. EEK.

To keep afloat we did what we could without destroying our credit, going delinquent or getting in over our heads. We had 2 credit cards already and opened up 3 new ones which all have 0% APRs currently. Two of them will be paid off completely in Sept when their 0% APRs expire. A third credit card ($1900 @ 12% APR) will be paid off either next month or by Sept. So, at least that's SOME progress!

That leaves two credit cards:

USAA - $13,720 @ 5.99% APR (no expiration)
Citi- $7,950 @ 0% (until Dec 31)
CURRENT TOTAL (these 2 cards only) - $21,670

Obviously I had hoped that we could pay off the Citi card before the 0% expired, but at this rate that is not going to happen. The post-intro APR is probably going to be about 13%, which I'm not looking forward to.

Coincidentally, just yesterday I got a 0% balance transfer offer in the mail from USAA. The transferred balance would get 0% until July 2007 -- six months beyond Citi's 0% period. BUT... We only have $3300 available on the USAA account to use for the balance transfer. That's going to leave about $4700 on the Citi card. Based on our payment budget, it will still be around $4000 when the 0% expires and the 13% APR kicks in.

So, now that you have all the details... Here's my question:

I have about $8000 in my old 401k. I left my previous job in January but did NOT roll it over. (I do have a Roth IRA, BTW.) My mom suggested that I look into cashing it out, paying the 10% penalty fee and applicable taxes, and use the remainder to pay off the Citi card. (She also mentioned that if I wait to cash it out until January 2007, then I won't have to claim it on my tax returns until 2008, so that gives us a bit more time to save up for that.)

I've done a little bit of research about this online, but I haven't had much luck. The things I end up finding about cashing out 401ks are either too technical for me to understand, or don't go into enough detail in plain English. I realize there are hardship qualifiers for cashing out and avoiding the tax, but our situation doesn't seem to be eligible for that.

Another thing is, most online resources that discuss cashing out 401ks seem to say the same thing: "DON'T DO IT!" But we are living hand-to-mouth as it is. I don't want to be paying off this debt for years and years. I feel that if we can at least limit our debt to our very low interest USAA card, that will help us really chip away at it.

So........ What do we do? Do we cash in my 401k? Do we forget about cashing it in, and instead roll it over to my Roth IRA, so we can use those funds for a downpayment on our first home (whenever THAT will be!)? We have plans we'd like to start fulfilling -- owning a home, starting a family -- but we can't until this debt is eliminated, or at least mostly gone.

Any thoughts?? If you have any other suggestions for how to get rid of this debt that are unrelated to the 401k thing, feel free to post those as well.

Sorry so long... Thanks for reading and I'd appreciate any feedback.

~ Jenney

[Tree0164]

Jenney

Do not cash out that 401k move it into a Rollover IRA.


Don't move it in a Roth. You will be paying taxes on it now.


I highly recommend reading Dave Ramsey's Total Money Makeover. He does it baby steps
First one is getting a small emergency fund and cut up those credit cards.


If you are living paycheck to paycheck you need to cut down on your expenses (do you have a budget) and maybe need to increase your income. Get a second job if you or your spouse can.

[Diolla]

Originally Posted by neatdesign

So, now that you have all the details... Here's my question:

I have about $8000 in my old 401k. I left my previous job in January but did NOT roll it over. (I do have a Roth IRA, BTW.) My mom suggested that I look into cashing it out, paying the 10% penalty fee and applicable taxes, and use the remainder to pay off the Citi card. (She also mentioned that if I wait to cash it out until January 2007, then I won't have to claim it on my tax returns until 2008, so that gives us a bit more time to save up for that.)

~ Jenney

First-The reason most people say don't is that you are looking at a lot more than a 10% penalty. At my work they also take out an additional 20% for income taxes on the withdrawl. You say you have $8k in the account so you would probably actually get around $5600 then if you owe more than 20% income tax you would have to come up with the rest at tax time. You would be losing approx. $2400 if you cash it in. Would you lose that much even if the CC was at 13%?

Second-You can't roll it over into a Roth unless you pay the taxes on it. Best bet would be to roll it over into a traditional IRA for now and maybe convert later when your finances are more stable.

I think your best way is the way you are doing it. Keep going with your plan and move as much as you can to lower interest cards. You might look to see if there is anything you could sell or maybe a second job temporarily until you can get out of this hole.

[neatdesign]

Thanks to you both for your very quick responses. Moreover, I appreciate you explaining the "Don't do it" issue to me in terms I can understand.

Although I know Roth IRA contributions are taxable upfront, I wasn't aware that you couldn't roll over a 401k to a Roth IRA. I definitely want to roll it over so I can have all my banking with the same company (USAA), so I'm guessing that I can open a traditional IRA to roll over the 401k, then eventually roll THAT over into my existing Roth IRA. Or can I only convert the traditional IRA into a second, separate Roth IRA account? Hmm...

Theresa, thanks for the book suggestion. Lucky for us, my husband works at Barnes & Noble so he gets a 30% discount on books! I'll definitely look into that one. I have "Personal Finance for Dummies" which has been a great resource in the past, but given our situation it might be a good idea to seek out other forms of guidance.

Diolla, I totally know where you're coming from. I have just applied for a new job this week -- fingers crossed! -- which will (hopefully) bring in a bit more income. We also have some stuff that we can sell on Ebay; we just need to get in gear and do it!

We're still getting 0% APR offers, several a week, actually. However, I have really high standards when it comes to offers, and read the fine print ruthlessly. I left my last job as a call center supervisor for Capital One because of work-related stress, but if there's one good thing that came out of that job, it's that I know what to look for in the fine print! I'm also a firm believer in trying to space out credit applications by 6 months to a year. The last credit card we got was in January, so if we can get a 0% offer towards the end of this year, we might be able to move the remaining Citi balance right before its 0% expires. That would be ideal.

Oh, here's another question: Once we've paid off the two cards that are at 0% right now, should we keep the accounts open? They'd each be a year old at that point. Or should we just close them and be done with it?

~ Jenney

[sweeps]

I agree with the others, do not cash out the 401k. Roll it over to a traditional IRA, perhaps at Vanguard or Fidelity.

Your cards get paid off the fastest when you put everything you can toward the one with the highest interest rate (while of course still paying the minimum on the others). Then you put all you can toward the card with the next-highest interest rate, and so on. Unfortunately it gets tricky when you have a temporarily low interest rate. You could let a 0% go for a while, but if it expires, you could be paying huge interest.

Don't close the cards after you've paid them off. Keep them open for good credit history. (Just don't rack up the debt again. )

[kristinecfp]

Jenney,

It sounds like you've made great progress already, so I will echo the others advice to NOT cash out your 401K. It does not make sense to cash out a 401K and pay a 10% penalty plus income taxes for a credit card with a 5% (or even 13%) interest rate.

I would just keep plugging away at the credit card debt, use any overtime, bonuses, tax refunds, etc. to help pay it down faster, and keep from using the credit cards any more, if possible. You should also get started on an emergency fund so that you don't find yourself in this situation again. Much easier said than done, I know!

Good luck,
Kristine

[neatdesign]

Ok, after reading everyone's responses and looking up a bit more about cashing in 401ks, I'm going to go along with the consensus and forget about cashing it in. It just seemed like a possible solution at the time, but admittedly that was before I really knew anything about it. I've already emailed my bank (USAA) to see what I need to do in order to open a traditional IRA for the rollover, and then what I need to do to transfer the funds again over to my existing Roth IRA (also with USAA). I'm unclear whether I can actually do this, or whether I will simply have to end up with two separate Roth IRA accounts. (I hope not!) I'm awaiting their response.

Sweeps, thanks for your suggestion on how to allocate debt payments. Actually I have figured out what will work the best for us, given what we earn and can afford to pay, is to focus on the "snowball payment" approach. For instance, in two months time we will have 3 of our 5 credit cards paid off. That means that $270 in monthly payments will be freed up to go elsewhere.

Instead of just keeping those funds in our checking or savings account, we'll reallocate them towards the other two remaining balances. Currently we pay $315/month to USAA and $120/month to Citi. We can up those monthly payments to $400/USAA and $305/Citi. Or perhaps $375/USAA, $230/Citi and $100/savings. Since those are way more than our actual minimum payments due, we should be able to chip away at it all much faster.

Kristine, I can appreciate your comments about an emergency fund. We actually had some savings but went through that before we decided to apply for more credit cards. We still have some savings left, about $2500, in our ING savings account @ 4.25% APR. Some of THAT will go to pay off our $1900 MBNA card next month. The rest I don't want to touch.

We don't use our credit cards anymore, haven't in months. Everything comes out of our checking account now. Any "extra" cash we get, like birthday checks, etc., go directly into the savings account. (Our birthdays are in December and February, so we have a bit of a wait for anything like that again!) One upside of using the MBNA card was that we accumulated enough rewards points to get $120 cash back check. We just need to redeem that, then put those funds right back out there to pay down debt. (For the same number of points we only qualify for a $100 gift card -- go figure!)

These forums are so great because everyone is so encouraging and understanding. Everyone's kind words make me feel like maybe there's some hope to dig out of this.

~ Jenney

[Tree0164]

Jenney
You can't move a 401k directly into a Roth. You would need to open a Traditional IRA and once the Traditional IRA is established you can then make that a Roth IRA. I would live it alone because you will need to pay taxes on it right now. I would focus on getting the credit card debt paid off.

[Diolla]

As far as closing credit cards I personally don't have any but if you need a good credit score you could leave a couple open after they are paid off. I wouldn't however leave them all open alot of unused credit lines can hurt rather than help when trying to get a mortgage. Once thay are all paid off I would suggest you cancel all of them except maybe a couple that have good terms for you.

That said, FICO scores are overrated. I have no credit cards or loans and recently purchased a small house with no difficulties. I did however have a large down and an extremely small mortgage amount.

[neatdesign]

Tree -- Thanks for your response. I'm aware that I can't rollover into a Roth IRA, that I'd have to open a traditional IRA first, then roll THAT over into a Roth IRA. What I wasn't sure about was whether I would be able to roll the funds over into my EXISTING Roth IRA, or whether I'd end up having to open a second Roth IRA. I got an email back from USAA this morning that confirmed that I can do the former, which is what I want. I agree it is best to wait until next year to do this, for tax purposes.

Diolla -- After thinking about it, I'll probably close just one or two of our credit cards if I close any at all. Of the three accounts, one (the oldest) is joint, one is in Mark's name only and the others are in my name with Mark as an authorized user. Since Mark is new to this country -- he emigrated from England three years ago -- his US credit history is very new so I want to make sure his individual account has time to build up a solid history.

I should point out that, despite the credit card debt we have now, we do NOT normally use our credit cards. We basically went to them as a last resort when we had no other means or savings to keep afloat. So simply having the credit cards does not mean that we will automatically use them.

~ Jenney

[Ima saver]

Sounds like you are on the right traack. Good luck, you can do it!!

[Diolla]

Originally Posted by neatdesign

Diolla -- After thinking about it, I'll probably close just one or two of our credit cards if I close any at all. Of the three accounts, one (the oldest) is joint, one is in Mark's name only and the others are in my name with Mark as an authorized user. Since Mark is new to this country -- he emigrated from England three years ago -- his US credit history is very new so I want to make sure his individual account has time to build up a solid history.

I should point out that, despite the credit card debt we have now, we do NOT normally use our credit cards. We basically went to them as a last resort when we had no other means or savings to keep afloat. So simply having the credit cards does not mean that we will automatically use them.

~ Jenney

I agree if you want to build up his credit definitely keep the one in his name. I had assumed from your original post that you had at least 5 open accounts. If you go in for a mortgage, even with excellent credit scores, and have 4-6 accounts with a possible $25-50k credit line the bank will be concerned you might use all that available credit and have trouble paying your mortgage. It sounds like you have the right idea though.

I did not mean to imply you would use them indiscriminately. I am one of those people who is allergic to plastic, if I have one I use it promising I will 'pay it back' and then don't. The only way I know to deal with it is to not have any, like an alcoholic I can't even have one stashed away, just in case. I put a permanent opt out on my credit report so I don't even get offers anymore (boy is my mailbox empty most days )

From your posts it sounds like you know what to do and have the drive to do it so about all I can add is an 'atta girl' I know you are going to be alright!

[neatdesign]

Thanks, everyone! You're all very kind. Like I said, it really is nice to get reassurance from others. I've never been in this situation before and I'm just trying so hard not to mess anything up.

Diolla -- No worries. I did not read your comments in a negative light and was not offended by anything you said. I guess I just wanted to point out to anyone reading this thread that this is not a bad habit or something, that we only used the credit cards out of necessity and as a last resort. For many people credit card debt is a chronic problem. I know -- I used to work for Capital One and talked to people all the time who struggle with it because they DO use them indiscriminately.

That's not to say that Mark and I are perfect when it comes to personal finance. Obviously we're not or we wouldn't be in this position. In fact, I find that I feel a lot of shame about it, because as smart, well-educated people we should have been better prepared for the unexpected. And I suppose I don't want other people to think that about me, either. Hence the explanation/justification written above. I'm gradually starting to get to the point where I don't really worry about feeling bad about what's happened, and instead try to remind myself that I did the best I could with what I had. That, and convincing myself that we'll dig out of this and eventually be able to move forward.

~ Jenney

[neatdesign]

Ok, just thought I'd post a little update...

I submitted a balance transfer request to USAA online tonight. They will be sending Citibank $3300 in the next week or so. This is in response to the BT offer I got for 0% through July 2007. I transferred as much as I could but left a $500 buffer of available credit, just in case. (Always best to leave a little extra wiggle room!)

At first I wasn't going to do the BT when I discovered that it would be considered a cash advance and be at 15.9% APR after the 0% expires. But I figured that if I can obtain another 0% card a month or two before this current offer's 0% expires, then I can transfer some or all of it over.

Most credit card companies limit BTs to 1) accounts where the applicant is an account owner; and 2) accounts with other companies. However, since our USAA account is a joint account, and since the new card won't be with USAA (they don't offer 0% credit card intro rates), either one of us can apply for and do the balance transfer to the new card. That was a major reason I decided to take advantage of this BT offer now, even though it's technically posting as a cash advance.

I realize that some of the $3300 I'm transferring now might still be on there -- cash advances are almost always paid off LAST -- but the overall USAA balance will be much, much lower a year from now. It's a gamble but I figure it's not much worse than having that extra $3300 at 13% on the Citibank card starting in January. At least this will allow us to wait another year before we need to apply for a new card. (And, just to clarify, we'd only be getting that new card to take advantage of the low APR, not to spend it!)

I also went to Egreetings and sent myself an ecard, which I've scheduled to receive next April. This ecard will just remind me to start looking for a new 0% offer so I can do another balance transfer before the July 2007 expiration. (If you've never tried it, it's an excellent way to remind yourself of stuff you'd otherwise forget! You can schedule ecard deliveries a year in advance.)

~ Jenney

[JoyJoy]

I was able to wiggle out of a similar position with my credit cards. I opened a savings account with HSBC last March, 2006 . I called HSBC about automatic transfers and they asked me if I was interested in a 0% balance transfer for 12 months. I told the customer representative that I would speak with HSBC's credit card division. Somehow we got disconnected and I decided that day not to pursue the balance transfer. A month later, after I paid off one of my credit cards, I went online and applied for a HSBC card hoping that I would get atleast a $5,000.00 credit limit to pay off my $4,800.00 remaining credit cards. I was approved for $15,000.00!! More than enough to take care of my needs. HSBC Mastercard has been pretty generous with their credit lines and 12 months more at 0% would help you too if the credit limit is adequate. HSBC Mastercard gives instant decisions online. Just an alternative to think about and keeping your 401K.

[JoyJoy]

By the way, good luck! Things happen to all of us....whether it's debt or something else; none of us are exempt from hard times.

[jamreed02]

I totally agree with the others. Don't cash it in... you lose so much money doing that. Roll it into a traditional IRA. The investment is going to bring in some interest, which will at least help counter the interest you'll be paying on the credit cards, if not completely overshoot it. I highly recommend Dave Ramsey's website (google it) It'll give you the basics, and then go to the library and check out his book (don't spend money you don't have). Then check out the frugal ideas on this site, and pinch pennies till your fingers hurt. You may want to read the Complete Tightwad Gazette for ideas. To start brainstorming, use the three frugal rules: 1. Buy it cheap, 2. Make it last, 3. Use it less. One great resource I've found for the frugal is www.freecycle.org

[more freedom]

That depends on your rate of return from your 401K and the internet rate of your credit card.

Say your credit card int rate is higher than the rate of your investment, then it makes more sense to pay out your credit card debt first.

hope this helped

[autoxer]

Originally Posted by more freedom

Say your credit card int rate is higher than the rate of your investment, then it makes more sense to pay out your credit card debt first.

That part is sound advice, when talking about some low interest savings account. However,

Originally Posted by more freedom

That depends on your rate of return from your 401K and the internet rate of your credit card.

The penalties and lost opportunity cost of cashing out a 401k are likely far worse than the interest. And if it came to bankruptcy, the 401k would be exempt.

[b4freedom]

The sad thing about borrowing money to pay off credit card debt is that people who do usually end up with a lot more credit card debt. Cashing out 401k is borrowing from your future and an easy emotional way out. Leave 401k alone and pay off your credit cards.