Taking a Hit to Pay Back
Kevin has been through a lot in recent years and owes money to family. Does Dave agree with his plan to pay the debts off?
QUESTION: Kevin in Florida went through a divorce, bankruptcy and foreclosure a few years ago. He has debt owed to his brother ($3,500) and sister ($4,000). He wants to know if he should cash out his $8,700 in stock in order to pay the family back. What should he do?
Dave's ANSWER: You need to find out what kind of a program this stock is in. If it's in something that qualifies as a retirement plan, then the government is going to take a large portion of it in penalties and interest. You don't have $8,700; it's more like $5,000.
If we classify it as retirement, then you should be able to liquidate the stock and role it to an IRA. If you can do that, then what I normally tell people is that the only time I cash out retirement accounts is to avoid a foreclosure or bankruptcy. Obviously you're facing neither of those.
You will give up about 30 or 40% of this money by cashing it out if it's in a retirement plan. You are borrowing money at 30% interest to pay someone off. You won't even be able to pay both of them off. You'll only be able to pay one off and just a portion of the other.
You don't want to do this, because we don't want to owe the IRS money. We are not going to take the money to pay off your brother and sister and hope you get the money by April. You are going to pay about 35% interest. You wouldn't go take out a loan at 35% interest, so what's the difference between that and this?
I'd work out something where I worked an extra job, maybe deliver pizzas five nights a week and make an extra $1,500 a month to pay them off in four or five months. I would liquidate the account and roll it to an IRA, but I wouldn't give up 35% of the money just to get rid of this uncomfortable situation that can be solved by you starting to make the payments on time by being on a budget. Just $1,000 a month pays off the whole thing in seven months.
Get on a budget and start paying them on time. Do that first, and then second, really tighten the budget down and get your income up temporarily and try to address this head on. In a worst-case scenario, by September if you haven't cleared it, you may want to consider taking it out then. But I want to see if you can work your way through this.
Part of this is that you've been hammered with a divorce, a foreclosure, a bankruptcy, and now on top of that, you're feeling that the borrower is slave to the lender with your brother and sister. Your emotional gas tank is empty. Every little pin-prick now feels like an amputation.
Over Christmas, sit down and show them your budget and what you are learning in Financial Peace University. Tell them that you will not only be on time with the payments, but you are going to increase your income, decrease your outgo, and get this paid off in the coming year. I think they'll be cool with you then.