Managing Debt

5 Questions to Ask Before Using Retirement Funds to Pay Bills

April 28, 2011 by Gerri Detweiler 4 Comments

You may be tempted to turn to your retirement funds for emergency cash. In fact, a new Bankrate survey found that 19 percent of Americans—including 17 percent of full-time workers—have taken money from their retirement savings in the last year to cover urgent financial needs. The survey was part of Bankrate’s Financial Security Index.

Options include withdrawing funds from an IRA, 401(k) or 403(b), for example, or borrowing against a qualified retirement account. (You cannot borrow against an IRA or pledge the assets for collateral as a loan.)

According to the Bankrate survey, roughly one in four of the unemployed and those earning less than $50,000 tapped retirement savings. These workers may be the ones least able to afford raiding their retirements.

[Related Article: Roundup: Credit Cards for Retired Consumers]

Here are five questions to ask yourself before tapping retirement funds for emergencies:

1. How much will I really get?

On early withdrawals you’ll generally pay taxes and a 10% penalty. Depending on your tax rate, and the type of account, $10,000 withdrawn from your IRA, for example, could mean as little as $5500 available for you to spend. A tax professional can help you understand the true cost of cashing in retirement funds early.

2. Can I afford the payments?

If you borrow against your retirement account rather than draw money from it directly, you will typically have to pay back the balance, plus interest, over five years. Those monthly payments are likely to be substantially higher than, say, the minimum payment on a similar amount borrowed with a credit card. If you can’t afford to make the payments, you have to treat that amount as an early withdrawal—and pay taxes and penalties. In some cases, you may be forced to repay the remaining loan balance immediately if you leave or lose your job.

3. Will it really make a difference?

Using your retirement savings to pay living expenses or make payments on other loans (like credit cards, or even a mortgage) may simply amount to throwing good money after bad. If you experience financial problems after that money has been spent, for example, you may find yourself contemplating bankruptcy—a tactic you possibly could have taken before having depleted your retirement account. Since such accounts are usually safe from creditors in bankruptcy, you could wind up losing money that would have otherwise been protected.

4. What alternatives do I have?

Although you may feel the heat if you are at risk of falling behind on bills, take the time to look into other alternatives before using your retirement savings. Talk with a credit counselor and/or a bankruptcy attorney. Listen carefully to their feedback. After all, they’ve helped many other people with problems similar to yours, and they can help you make a better decision.

5. Am I on track with my retirement savings?

If you have ample money socked away for the day you’re no longer in the workforce, this may not be a big deal. But if you’re already behind, as many workers are, then using those funds early will only make it harder for you to retire someday.

Image: Bankrate.com