Being stuck in debt is no picnic. Getting rid of it as quickly as possible can free up money you need to work towards other financial goals. Figuring out why you want to get out of debt is important, but how you go about doing it is what really matters most.
There’s a right and a wrong way to slay the debt monster and if you choose the wrong path, you could end up costing yourself more in the long run.
1. Drain Your Retirement
If you’ve managed to build up a tidy sum in your employer’s 401k or an IRA, it can be tempting to tap into your savings to wipe out your debt for good.
While you’ll get the benefit of being off the hook to your creditors, you’re really only creating more problems for yourself in the long run.
There are some potentially serious tax implications of withdrawing money from a retirement account. If you take out a loan from your 401k, for example, you typically have to repay it within five years but the full balance is due immediately if you change jobs.
When you can’t come up with the money to pay it off, the whole thing gets treated like a regular distribution which means you’ll income tax on it when you file.
When a withdrawal from a 401k or traditional IRA occurs before age 59 1/2, a 10 percent early withdrawal penalty applies in addition to regular income tax.
You won’t pay taxes on withdrawals of your original contributions to a Roth IRA as long as your account’s been open for five years but taxes and the penalty do still apply if you pull out your earnings before hitting age 59 1/2.