Using the 401(k) Wrong

Marcus and his wife make $90,000 a year. His wife has $4,500 in a 401(k). Should they cash out the 401(k) and use that money to move to a new home?

QUESTION: Marcus in Waco is recently married, and he and his wife make $90,000 a year. His wife just started her job, and she has $4,500 in a 401(k). In six months, all of their debts will be paid off except for their home. Should they cash out the 401(k) and use that money to move to a new home? Dave tells Marcus while cashing out the 401(k) is a bad plan.

ANSWER: I wouldn’t recommend you move up in house until you have your debts paid off. I think you can do it pretty quickly, especially if you set that as your baseline and say that you are not moving until you get this paid off, so how deeply can we cut our lifestyle to get this paid off.

If you cash out the 401(k), it won’t be a 30% tax. You get hit with your tax rate, which is now 35% plus a 10% penalty. While they withhold 20% on you, they’re going to hit you with between 35% and 45%, depending on where you fall that year within your tax bracket. We do not cash out the 401(k). We roll that to a traditional IRA.

But there’s no question that you can knock out your smaller debts very quickly. The only question is do you buy a house before you get your $40,000 student loan paid off, and I don’t think you do.