Should you use your IRA to pay off debt?
Saving for retirement can be overwhelming, and paying down debt is certainly no less daunting. The two can become even more confusing if they are intertwined. Many people who have retirement savings and debt wonder if they should prioritize paying off debt over saving for retirement. The following information can help you determine if you should consider using your IRA to pay off debt.
The media has gone debt crazy in the past few years. Whether it is due to the continuous rise of tuition costs and student debt or leftover fear from the financial crisis, debt is always making headlines. This could lead you to believe that you have to pay down all of your debt as fast as possible, no matter how you do it, but that is not the case. It is important to consider the consequences of using your retirement accounts to pay down debt before making any withdrawals.
If you have money in an IRA, then you may be wondering if being debt free is worth dipping into your account. Because there are more penalties associated with traditional IRAs compared to Roth IRAs, it is more common for people with Roth IRAs to want to use money from their accounts to pay off debt. No matter which type of IRA you have, however, you should only withdraw from it as a last resort.
First, although there are a few exceptions, you will have to pay a 10 percent tax penalty if you withdraw from your traditional IRA before you are 59 ½ years old. Furthermore, you will have to report the money you withdrew as taxable income. This could have the unwanted consequence of raising you into the next tax bracket, which could be costly.
If you have a Roth IRA, you would not be required to pay a penalty for a withdrawal of your contributions because you already paid taxes on them. If you withdraw the earnings of your contributions before age 59 ½, however, you will be charged income taxes and a 10 percent penalty.
If you only plan to withdraw the contributions and not the earnings of a Roth IRA, it can be a tempting solution for paying down debt. It is especially tempting if you are battling high-interest credit card debt. Regardless, most experts agree that the money in your Roth IRA is more valuable to you if left there in order to provide you with flexibility in retirement.
“Roths aren’t subject to required minimum withdrawal rules after age 70 1/2, like traditional IRAs,” according to the “Ask the Expert” column from Time.com. “That means you can pull out a large sum for a health emergency in retirement without worrying about taxes. And if stock prices plummet, you won’t be forced to make withdrawals at a market bottom.”
These benefits are extremely valuable and likely can't compare with the benefits of paying down your debt if you can find other ways to come up with the money. If you cut down on expenses to raise the cash you need, you won't be creating long-term ramifications to your retirement. If you are tempted, it is important to keep in mind how you will be able to use the funds when you retire.
“In addition, money you take out of an IRA cannot be replaced, since you would still be restricted to yearly contribution limits for future contributions,” according to CNN Money. “So even if you withdraw only a small amount, factor in the years of compounding interest you would be forgoing, and that small withdrawal could end up costing you a small fortune in your golden years.”
If you are struggling to pay down debt, your financial institution is your best resource for coming up with a plan that works for you and your budget.
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