Should I Cash Out a 401(k) to Payoff Debt?

Cody is transitioning jobs. He's 23 and has $11,000 in a 401(k). He has $15,000 in debt. Should he cash out the 401(k) to pay down the debt?

QUESTION: Cody in Colorado Springs is transitioning jobs. He’s 23 and has $11,000 in a 401(k). He has $15,000 in debt. Should he cash out the 401(k) to pay down the debt?

ANSWER: When you take money out of a 401(k), they charge you a 10% penalty plus your tax rate. Your tax rate’s about 20%. That means that you’re going to get hit for 30%, so it’s kind of like saying, “Dave, I want to borrow $11,000 at 30% interest to pay off my debt.” That wouldn’t make much sense. Mathematically, even though it would feel really good to be done with all that stuff, mathematically, it doesn’t make any sense.

I tell folks not to cash out a 401(k) or an IRA to pay off debt unless it’s to avoid a foreclosure or a bankruptcy—and you’re not facing either one of those. I would not do that.

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