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Withdrawals from your IRA to pay credit card debts

Posted by Andrew Chan  April 23, 2010 03:30 PM

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I have a significant amount of credit card debt and can only make the minimum payments due to my other monthly expenses. The interest that I am paying on the credit card debt is very high. While I know it is not good to withdraw money from my IRA account before retirement, should I take money from my IRA to pay down my credit card debt?

During tough economic times, people often consider tapping their retirement accounts as a source of funds to help make ends meet. While this may seem like an attractive option, making a non-qualified withdrawal from your IRA before age 59.5 can be costly. The federal government (and some state governments) imposed steep penalties in order to discourage these withdrawals. The federal penalty is 10 percent of the taxable amount withdrawn (i.e., pre-tax or deductible contributions and earnings on those contributions). There is no penalty for withdrawing your after-tax or non-deductible contributions from your IRA.

In addition to the penalty, amounts withdrawn are subject to federal and state income taxes unless the withdrawal includes after-tax or non-deductible contributions. For example, a $20,000 withdrawal would cost you approximately $7,000 in taxes and penalties (assuming a combined federal and state tax rate of 25 percent and an early withdrawal penalty of 10 percent).

I generally advise against taking an early distribution to pay off your credit card debt for a variety of reasons including the out-of-pocket costs mentioned above. That said, I can certainly appreciate the financial, emotional, and psychological benefits associated with reducing or ridding yourself of your credit card debts. From a short-term, financial standpoint, I think you should evaluate if it is worth the cost of the penalties and taxes to rid yourself of your credit card debt. Just as important though, is determining how you can satisfy your monthly expenses without incurring new debts while continuing to save and replenish your retirement funds.

As a final note, there are exceptions to the 10 percent early withdrawal penalty. If any of the follow apply to your situation you may be able to reduce the impact on your retirement savings of making an early withdraw. The exceptions include withdrawals made for:
  • Medical expenses (to the extent they exceed 7.5 percent of your Adjusted Gross Income),
  • Health insurance premiums paid by unemployed individuals,
  • Qualified higher education expenses,
  • First time home purchases (up to $10,000 dollars per lifetime), and
  • Individuals called to active duty.
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ABOUT MANAGING YOUR MONEY
Local finance professionals share insights and advice on issues such as budgeting, managing debt, and retirement planning.

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D. Abraham Ringer is a CERTIFIED FINANCIAL PLANNER practitioner and a Financial Adviser with Morgan Stanley Global Wealth Management in Boston. He is registered in MA, NH, NY and several other states to which his articles are directed. For more information please visit www.morganstanleyfa.com/ringer
Financial Planning Association™ of Massachusetts has 900 members who specialize in the financial planning process. Many of its members engage in philanthropic pro bono work in their communities, recommend legislation, elevate public awareness, promote financial literacy, and advocate for sound economic and tax policies.
Odysseas Papadimitriou is the founder of CardHub.com, a credit card and gift card marketplace, and WalletHub.com, a personal finance site. He has more than 13 years of experience in the personal finance industry, and previously served as senior director at Capital One.

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