The fastest way out of scary debt can quietly cost you the retirement you’ll need later.
Prefer to watch? Here's the quick video version of today's issue.
Dad Joke
I just got a new job as a guillotine operator.
Beheading there shortly.
Off the table
Someone using the free Ask Steve chat on my site laid out their credit cards for me last week. More than twenty of them, most charging close to 30% interest, some with monthly fees on top. The minimum payments were eating about half of what they bring home. Their credit union had already turned down a personal loan and a home equity line.
When the chat gently asked about bankruptcy, the answer was “off the table.” Asked what was behind that, they didn’t say. Near the end, they told me what they wanted most. “Urgency so I can have peace.”
I understood that. But the urgency isn’t what stuck with me. It was the refusal to look at every option to get rid of the debt, out of fear of how it would feel. This is a story about emotions beating math.
That’s why I wanted to pass this along.
When the usual doors close, a lot of people turn to their 401(k). You may have seen ABC News ask whether you should use your 401(k) to pay off credit cards. It’s a fair question when you’re scared. But an expert told them that paying off $20,000 of card debt that way can mean taking almost $30,000 out of the account, once taxes and penalties come out.
That’s not the full story, or the worst part. The real math doesn’t lie, and that number is much scarier.
Say you’re 45 when you do it. That $30,000 doesn’t just cost you the penalty and the tax this year. Left alone until you’re 65, it could have grown to something like $116,000 if it earned about 7% a year, or around $80,000 at 5%. Those are assumptions, not promises. But that’s the real price of clearing $20,000 of cards.
A lot of people think a 401(k) loan is the safe version, because the rate is low and the interest goes back to them. Here’s the truth about that rate. It isn’t really what you pay. The interest comes out of your own paycheck and goes into your own account, so it’s your money either way. What you really pay is the growth that money missed while it was out of the market.
Say you borrow $20,000 at 45, pay yourself 5% while the market earns 7%, and pay it all back on time over five years. Your account comes up about $3,300 short at 65. That’s the good outcome. And let’s hope you don’t change jobs or lose your job while that loan is out. If you can’t repay it by the time your taxes are due, it’s treated as a withdrawal. You pay the tax and the 10% penalty, and your account is about $77,000 short at 65.
Here’s the part I want you to hear. Reacting urgently to make the fear and shame go away, without a plan that makes mathematical sense, only throws away a big future retirement savings amount.
The option this person wouldn’t look at generally leaves a 401(k) untouched. I’m not saying it was the right answer for them. I’m saying they never looked. They’d been asking other AI chatbots, which were guessing at what a monthly plan payment might be. And they turned down a free first call with a debt coach, because, as they put it, when something is free, you’re the product.
I get that instinct. A lot of “free” help really is selling something. But the fear was making the decisions, and the math wasn’t getting a vote.
So the reality is, people throw away substantial retirement money over how they think they will feel. There are other options that can avoid that and make mathematical sense.
Here’s the one thing I’d do before choosing any plan. Put every option on the table, even the one you’ve already ruled out, and write two numbers side by side: what all your minimum payments add up to in a month, and what you actually take home. If the first number is anywhere near half the second, that isn’t a budgeting problem. It’s a math problem, and it deserves a plan that still works three years from now, with your retirement still in it.
I wrote more about why cashing out a 401(k) to pay off debt is almost always the wrong move, what it really costs you later, and the other ways out.
Anyway, I wanted you to have that before a scary week pushes you into a fast decision.
When money gets scary, do you tend to act fast or freeze? Share it in the comments so we can all learn from it. I read every comment.
Wanting it to stop isn’t a weakness. It usually means you’re ready to deal with it. Looking at every option, even the scary one, is where every real way out starts. I’ll see you tomorrow.
— Steve
Also on the site since yesterday: how I’d get a judgment fixed when it landed on the wrong account, who actually qualifies for Equifax’s $30 million hard-inquiry settlement, and what the FTC’s warning to hospitals about pricing means if you’re uninsured or paying yourself.
SEE A SCAM? SAY SOMETHING. If one has landed on you or someone you love, tell me at tips@getoutofdebt.org. The ones that can warn other people may show up here. Leave out account numbers and passwords.
If any of this was new to you, somebody you know hasn’t heard it either. It’s free at yourmoneyactually.com, and I don’t sell the list. The places I actually use for my own money, and what I get out of telling you, are on one page where they’ll always be.
This is what I’m telling friends like you over coffee. But remember, you do you.