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Ask Dave

Why You Shouldn't Cash Out

Marcy is about to make a dreadful mistake with her 401(k) retirement plan.

QUESTION: Marcy in Indiana wants to know if they should cash out a 401(k) to pay off student loans. Dave says no way.

Dave's ANSWER: No! You don’t cash out a 401(k) or an IRA to pay off debts unless it’s to avoid bankruptcy or foreclosure, and here’s why: If you take, say, $50,000 out of your 401(k), they are going to charge you a 10% penalty plus your tax rate. If you make $75,000 a year, that would put you in a 25% tax rate plus your penalty. That’s a 35% hit. That’s how much of your $50,000 is going down the toilet. That’s $20,000, which is almost half your money.

You wouldn’t call me asking if it’s all right to borrow money at 35% interest to pay off your school loans. That would be silly, so this is just as silly. There’s no shortcut. You have to roll up your sleeves. Beans and rice, rice and beans. Get on a written budget where every dollar has a name, and get rid of the debt. That’s the only way out.