Cashing Out 401k To Pay Debts

By Sean A. Kelly

Fred is an employee at a local transportation company. Like many other employees in the United States, he has his own retirement fund account. However, like many other people, he also has his own debts to pay. At one point, Fred needed to take a drastic step to make sure that his overdue debts are paid. So he decided to explore the option of cashing out 401k to pay off his existing debts. When he told his friends and relatives, they were all immediately against the idea. After all, his 401k retirement account is supposed to function as a cushion so he would have a financial fallback after he retires later on. They believed that withdrawing from his retirement fund to help pay off his debts would only cause him more harm than good. But Fred was already feeling like he had run out of options so he went ahead to access his retirement fund.

Fred decided to apply for a loan out of his retirement fund. Basically he would be cashing out 401k but later on would put it all back into his retirement account. So he was happy when he found out that he would be able to enjoy a very low interest rate. Furthermore, the interest rate that he would be paying would go directly into his account as well. This is different from when he was paying off his debts individually where the interest rate was rather high. He also had to concentrate only on paying off this one debt instead of making payments to several creditors. Of course, what Fred probably did not realize is that although the interest rate of a 401k loan is considerably lower and that he had enough funds in his 401k account to cover his debts he would also probably be setting back the amount in his account.

When Fred decided to borrow or cash out 401k to pay off his other debts, he was told by the retirement fund officer that he would have to pay back the amount he owed within 5 years. 5 years sounded like a long enough time to him and that is why he probably thought that he would be able to pay back his loan. So basically Fred would have to keep working with his current employer for at least 5 more years in order to be able to pay the debt back. However, due to some disagreements with his bosses, Fred decided to quit his job after two years. This was when the balance he owed on his 401k account became due and the amount he still had not paid was considered as cash out. This means that by the time he retires he probably would not have enough in his funds.

The one thing that Fred disliked about his loan was that he had to pay 401k taxes to both state and federal government. On top of that, he also had to pay a 10% early withdrawal penalty even though the amount he cashed out was meant as a loan. Originally it was but once that he quit his job, the amount he took out was considered as an early withdrawal. He thought it would not be such a big deal because he certainly could afford a few dollars in taxes. However, the taxes and penalty easily added up to 30%. That was when Fred realized that he probably made his decision to borrow from his 401k to pay off his debts at a time when he was emotionally distressed. He discovered that doing so probably helped him settle his former debts but on the other hand it also created a new problem in the long run. Now that he is actually of age to withdraw his 401k from his retirement account he discovered that he probably could have saved more if he did not take that loan.

Fred learned his lesson the hard way and he probably should not have touched his 401k account to help him pay off his debts. He learned that although borrowing from his 401k was an option, it was not the only option. He probably could have tried debt consolidation or other methods to help him pay off his debts. However, whats done is done.

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