When counseling someone with a debt problem, I usually have to explain to them that the easy way is often the worst way.
Consider the individual with several maxed-out credit cards. Of course, they want to get rid of them. So, they look at their 401K account and notice there’s enough money in there to pay off all their credit cards.
They tell themselves they can then save all that money they were paying to the credit card company and pay back the 401K.
If they ask my opinion, my answer is usually – No. Their words are saying one thing, but their actions deliver a very different message.
With their words they say they hate debt, want a fresh start and promise to be a disciplined saver. But with their actions they say they love debt (after all, they have obtained all of it you can get), they want an easy way out and they have never saved any money in their lives (which is why they have so much debt).
Money woes often have little to do with math. Forget high interest rates and what makes the most mathematical sense. Look in the mirror and say to yourself, “The problem is not math. The problem is me.”
Here are several things that can or will happen if you use your retirement account money to pay off your credit cards:
1. Taxes. If you take money from an IRA, 401K or other similar retirement plan, you will owe income tax on that money. For the average person, that could end up being 15% to 20%.
2. Penalties. In addition to the income taxes, if you are under age 591/2, you will owe a 10% early withdrawal penalty on top of the other taxes you pay. So now you’re up to 25% or 30% or more in taxes and penalties. Are your credit card interest rates that high?
3. Re-load. But the worst thing likely to happen is that you’ll go right out and re-load those credit cards and max out the limits again. If you do, you’ll be right back where you are now, minus a bunch of money from your retirement accounts. That’s because you will have done nothing to change the most determinative part of this whole equation – your habits.
If you want to change your financial life, you’re going to have to change your financial habits.
If any of this is sounding familiar, here’s what I suggest: do the hard thing rather than the easy thing. That way the results will be easy to live with (as opposed to hard to live with).
The hard thing would be paying off the credit cards before doing anything else. If you are making contributions to a retirement plan or saving money anywhere else, you can redirect those payments to paying off your debts. This could take several years to pay off the debt, so it certainly isn’t a quick fix.
But once you’ve actually gone through the (hard) process of paying off your credit cards, something very important will be different – you. You’ll be different. Your habits will have changed and you’ll have the experience of doing the right thing financially over a long period of time.
Then you can look in the mirror and say to yourself, “The solution was not the math; the solution was me.”
Be your solution. Skip easy - do the hard thing.