Dear Carrie: When I turn 59 and a half, I think it would be a good idea to withdraw $40,000 from my 401(k) to pay off high-interest rate credit cards (24 percent APR). I plan to continue working until I'm 65, and my current 401(k) balance is more than $500,000. I know that the $40,000 will be taxed according to my income level. Good or bad idea? -- A Reader
Dear Reader: While I almost never recommend taking money from retirement savings before you actually retire, your situation is one of the few where it could make sense. First, you seem to be on a pretty solid retirement savings track, especially if you stick with it until you're 65. Next, by waiting to withdraw the $40,000 until you're 59 and a half, you won't be hit with an early-withdrawal penalty. Finally -- and this is where such a move could really pay off -- by getting rid of your high-interest credit card balances, you're giving yourself the equivalent of a 24-percent gain. Yes, you'll have to pay income taxes, which might mean your realized gain is 10 percent to 15 percent depending on your income, but that's still a very good return.
Another alternative is (SET ITAL) borrowing (END ITAL) the money from your 401(k). I rarely recommend this, either, but if your company's plan has a loan provision and you qualify, it could make sense. Provided you abide by all of the rules, there are no taxes or penalties. Plus, the interest rate is generally quite low -- and you'd have the motivation of paying yourself back.
But whether you take a distribution or a loan, the danger is falling back into debt once you pay off your balance. Fortunately, it's in your hands to make sure this doesn't happen. You don't say how close you are to 59 and a half, but whatever your age, here are some steps you can take to assure you get a handle on your debt even before you tap into your 401(k).
Commit to Cash
As hard as this is in today's world, commit to changing the credit card habit, and use only cash. Much research has been done showing that people are willing to spend more when they use a credit card than when paying cash. A study published in the Journal of Consumer Research in April 2012 goes even further, suggesting that when paying with a credit card, the purchaser focuses on the benefits of the product they're buying, but when paying with cash, the focus is on cost. To stay out of debt, you need to focus on cost and what you can afford -- no matter how much you like or want the product. Paying with cash is the best way I know to do this.
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