How to Get Out of Debt - Use Your 401(k)
Since many individuals simply do not have the funds available to pay off all of their debt in one lump payment, they must choose to either negotiate a lower payment arrangement with their creditors or find some other means of obtaining the money that they need. Often times, this can be done either with a home equity line of credit, a personal loan from a friend or family member, borrowing money against a life insurance policy or by borrowing against a 401(k). While each method has its advantages, there are a few reasons a person may want to focus on their 401(k).
Of course, not everyone has a home with enough equity in it to borrow against and many individuals do not have a cash value life insurance policy. This is one of the biggest benefits to a 401(k). Most companies offer a 401(k) retirement plan to their employees and most of these plans allow individuals to borrow $50,000 or 50% of the value of the account. The interest rate charged on these plans is also generally only a pointer to above the prime rate making them much lower than even the most attractive credit cards.
There are other benefits to using this method aside from the lower interest rate. Because the 401(k) contains funds that already belong to the individual, they are essentially borrowing money from themselves. This means that the money being paid back and the interest being charged all goes directly back into the individuals account. Basically, a person is borrowing their own money and, after they pay the money back, they will have more in their account then they did originally. Unfortunately, like most of the options available to an individual when it comes to borrowing money, there are some drawbacks to this method as well.
Any money borrowed against the 401(k) must be repaid within five years and both the interest and the loan will be paid back with money that has already been taxed and the interest that is repaid will be taxed once more once an individual withdraws their money from their policy. Additionally, an individual under the age of 59 will also incur a penalty tax of 10% for withdrawing their retirement funds early. In order to best determine whether or not this is the right course of action, a person have to carefully weigh both the pros and cons of borrowing money against their 401(k) to get out of debt.