When struggling with debt, it’s tempting to use your retirement savings to help pay off outstanding balances. However, there may be penalties, taxes and other drawbacks.
Before using your 401(k) to pay debts, you’ll want to:
— Understand the implications of a 401(k) withdrawal.
— Be aware of emergency personal expense distributions.
— Know how a hardship withdrawal works.
— Consider a 401(k) loan.
— Decide which option is financially right for you.
Understand the Implications of a 401(k) Withdrawal
There could be consequences if you cash out your 401(k) to pay off debt, especially if you’re younger than age 59 1/2, when early withdrawal penalties
typically apply.
“Income tax and penalties significantly reduce how much you have to put toward your debt,” said Leslie H. Tayne, founder and debt management specialist at Tayne Law Group in New York City, in an email.
If you withdraw funds before 59 1/2, the IRS generally treats it as an early distribution. That means you’ll owe regular income tax on the amount taken out of a traditional 401(k), plus a 10% early withdrawal penalty.
For example, suppose you withdraw $20,000 to pay off debt. If you’re in the 22% tax bracket, you’ll owe $4,400 in income taxes. Additionally, you’ll have to pay the 10% penalty of $2,000, leaving you with just $13,600 to put toward your debt.
Once you reach 59 1/2, you won’t have to pay the 10% penalty. However, withdrawals from a traditional 401(k) will still be taxed as income. If you have a Roth 401(k) and have held the account for at least five years, qualified withdrawals can be taken tax-free.
Among the advantages of a 401(k) withdrawal is that you won’t have to repay those funds. Taking money from your 401(k) can make sense when paying off high-interest debt like credit card debt, Tayne said.
On the downside, tapping your 401(k) reduces your retirement savings. Without a plan to stay out of debt and rebuild those savings, you could face financial challenges again down the road.
[READ: How Much Are 401(k) Early Withdrawal Costs]
Be Aware of Emergency Personal Expense Distributions
The Secure 2.0 Act expanded access to retirement funds in certain situations. Under the law, you can take a penalty-free withdrawal of up to $1,000 from your 401(k) for emergency expenses, provided you repay the amount within three years and confirm that the funds are being used to cover an eligible emergency.
The law also provides relief for individuals affected by domestic abuse. If you are under 59 1/2, you can withdraw up to $10,000 or 50% of your account balance, whichever is less, without paying an early withdrawal penalty.
Know How a Hardship Withdrawal Works
In some cases, you might be able to withdraw funds from a 401(k) to pay off debt without incurring extra fees. This typically applies if you’re facing a serious financial need and meet IRS criteria. In those situations, a hardship withdrawal may be an option.
You might be eligible for a hardship withdrawal if you:
— Have certain medical expenses
— Need to pay funeral or burial costs
— Purchase a home for the first time
— Incur qualified educational fees
— Must repair your home after a natural disaster
Before you take a hardship withdrawal, confirm that you are eligible. You may also want to think about the long-term impact of tapping those funds. Withdrawing money now could leave you with less available funds for your retirement years.
Consider a 401(k) Loan
Some 401(k) plans allow participants to take loans, offering a way to access funds without going through a traditional lender.
“If you take out a 401(k) loan, you’re borrowing from yourself,” Tayne said. As you make payments with interest, you’ll gradually replenish the account.
“Typically, you’ll have five years to repay the loan,” Tayne said. Generally, you can borrow up to 50% of your vested balance or $50,000, whichever is less. For example, if your vested balance is $80,000, your loan amount could be up to $40,000.
One benefit of a 401(k) loan is that it doesn’t require a credit check or get reported to credit bureaus.
“Taking out a loan from your retirement savings will not hurt your credit score,” said William Haight, executive marketing director of Capital Choice Financial Group in Phoenix, in an email.
Even though borrowing from your 401(k) won’t show up on your credit report, there are important repayment rules to keep in mind.
“If you don’t repay as agreed, you’ll be subject to income tax and penalties,” Tayne said.
Leaving your job while you have an outstanding balance on a 401(k) will also have consequences. Depending on your plan, you may need to repay the balance in full within 60 days to avoid taxes and penalties.
[Read: How to Save in a 401(k) and IRA in the Same Year]
Decide Which Option Is Financially Right for You
Taking out a 401(k) loan means you’ll have less money invested and working for you, so it’s worth exploring other ways to pay off debt.
Alternatives to a 401(k) loan include a balance transfer credit card, which allows you to carry over balances from other credit cards and often includes a 0% introductory interest rate for a period. You could also consider a debt consolidation loan, which can combine multiple debts with high interest rates into one loan with a lower rate.
If possible, try reworking your budget. Perhaps you can pause contributions to the retirement account and use that money to pay down debt. Reducing other household expenses can also free up cash to put toward your debt.
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Should You Use Your 401(k) to Pay Off Debt? originally appeared on usnews.com
Update 04/14/26: This story was published at an earlier date and has been updated with new information.