Dear Liz, My wife and I no longer work. She is 57 and I am 55. We have retirement income of about $90,000 in military and Department of Defense pensions. We have several Roth IRAs and some mutual funds. I have a 403(b) with $75,000. Is it wise to tap retirement accounts to clear off a credit card and pay my car off early to get out of debt? I owe $17,000 on it at 4.2% interest. -- Jeff
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Dear Jeff, It rarely makes sense to prematurely tap a retirement account to pay off debt. It usually is much better to use savings or cash in nonretirement assets.
Withdrawals from your 403(b) retirement plan would trigger income taxes that would eat up at least a quarter of what you pulled out. While you wouldn't be subject to the 10% federal penalty because you are 55 and separated from your employer, you'd still wind up paying income taxes equal to your federal and state tax brackets. If you were in the 25% federal bracket, for example, a $20,000 withdrawal would trigger at least $5,000 in income tax (plus whatever your state charges).
Then there's all the future, tax-deferred growth you're giving up. If you left the $20,000 alone to grow until after you turn 70 1/2, when distributions start to be required, it would grow to more than $40,000, assuming an average 5% annual return.
That's a huge price to pay just to pay off a low-rate loan and get out of debt.
A 10% penalty for withdrawals made before age 59 1/2 applies to workplace retirement plans, except under certain circumstances:
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- You are 55 or older and you no longer work for an employer.
- A distribution is made to an alternate payee (such as an ex-spouse) under a Qualified Domestic Relations Order.
- You receive a distribution of dividends from an employee stock ownership plan.
Other exceptions apply in certain cases of financial hardship, death or disability.
You didn't mention how much you owe on your credit card or what the interest rate is. If the rate is high and you're not able to quickly pay off the debt from your current income, then you could consider cashing in some of the mutual funds or taking a withdrawal from your Roth. Roth withdrawals don't incur penalties or taxes if you take an amount equal to what you've contributed. Once the account has been opened five years and you turn 59 1/2, you can tap the Roth without owing any taxes at all.
Still, it's best to leave the money in retirement accounts alone to grow, if at all possible. Selling mutual funds will have tax consequences, so talk to a tax pro first.
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