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Should I Use a 401(k) Loan to Pay Off Credit Card Debt?

Created: On October 16, 2009 @ 4:53 pm In

If you are carrying a lot of [1] credit card debt it may be tempting to borrow money from your 401(k) plan to pay it off. But taking money out of a 401(k) can take a bite of your retirement nest egg over time. Here is what you need to know about borrowing money from a 401(k) plan.

Using a 401(k) to Help with Debt

Many Americans who need [2] help with debt have turned to 401(k) money. Many 401(k) plans allow you to borrow up to 50% of the vested balance, with the total withdrawal capped at $50,000, according to SmartMoney. In some cases the money can only be used for a home purchase, medical costs, or education expenses.

Paying Yourself Back with Interest

Generally, you have five years to pay yourself back with interest. Money that is not repaid on time is subject to a 10% penalty for early withdrawal, as well as income taxes. Also, if you leave your job before repaying the loan, you usually have a certain number of days to repay the full amount before it is subject to a penalty and taxes.

The Power of Compounding Interest

Another drawback to taking money out of your 401(k) is that you lose out on compound interest being earned on that money. This reduces the total amount of money that can be saved up for retirement.

If you are still making contributions to your 401(k), a better alternative to taking a loan may be to temporarily stop making contributions and divert that money to your [3] debt reduction plan to pay off credit cards.

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URL to article: http://www.debthelp.com/blog/2009/10/16/should-i-use-a-loan-from-my-401k-to-pay-off-credit-card-debt/

URLs in this post:
[1] credit card debt : http://news.cincinnati.com/article/20091016/BIZ01/910160366/1076/BIZ/Simply+Money++Paying+down+debt
[2] help with debt : http://www.smartmoney.com/Personal-Finance/Debt/Should-You-Borrow-From-Your-401k-or-403b-9657/
[3] debt reduction: http://www.credit.com/products/debt/Debt-Reduction-Do-It-Yourself.jsp