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Patrick O. Oswald
Patrick O. Oswald, Wealth Advisor
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Experience:  20 years experience on wall street with both major and boutique investment banking firms
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My wife and I have about $50k in unsecured, high-interest debt

Customer Question

My wife and I have about $50k in unsecured, high-interest debt (that is, credit cards). I would really like to get rid of it.

We also have about ~$60k liquid in employer-linked retirement accounts (previous employers, in both cases).

I could wipe the slate clean by withdrawing from the retirement accounts, but the withdrawals are taxable and include a 10% early withdrawal penalty, which will hurt. Unfortunately the retirement accounts do not allow for loans.

Is there a way to turn this debt from high-interest unsecured loans to lower-interest secured loans based on the retirement funds? Maybe by rolling the funds into a different type of retirement account? Or is there some other way I can attack these high-interest debts using these funds, while minimizing my tax burden?
Submitted: 2 years ago.
Category: Finance
Expert:  Rakhi Vasavada replied 2 years ago.

Dear Friend,

 

Even if your retirement accounts do not allow for loans, you may consider few other options as well.

 

You may consider to transfer tax-free your IRA, 401k from a previous employer, and other qualified retirement account to your Self-Employed 401(k) plan. After this, can borrow up to the lower of $50,000 or 50% of the balance in your Self-Employed 401(k) account. This type of loan is tax-free and penalty-free as long as it is paid back timely. Your principal and interest payments go back into your account. Therefore, a loan from your Self-Employed 401(k) can be smarter than a taxable withdrawal from your IRA (loans from IRAs are not allowed) or other retirement money to consolidate debt.

 

I hope you will find this option useful.

Warm Regards

Customer: replied 2 years ago.
Thanks!

Can I actually open a self-employed 401(k)? I work for a company...

If I'm understanding this right I could open a self-employed 401(k) with a rollover from my other accounts, then with $60k in that account I could borrow up to $30k? Presumably at a much lower interest rate than my credit cards (I have to follow that up with the 401(k) provider of course)?
Expert:  Eric replied 2 years ago.

I appreciate the opportunity to help!

Unfortunately a SEP IRA does require that you are self-employed and are earning an income from that employment. Even though you have a job, you could still be self-employed in addition. Opening the SEP IRA may be difficult and there are many restrictions about borrowing against it to payoff personal debt. Borrowing against any retirement account to payoff personal debt is a problem. Its' considered very risky and not what the accounts are made for. It is possible to make it work and you could also look at a self-directed IRA, but these are difficult to get set up and there are many guidelines and legalities. You may even have to pay fees to get help with setting all of this up legally (attorney). ANyway...its never completely suggested to raid retirement money to payoff debt, but this is a large amount of debt that you need to find a way to get out of. Debt free is best! Contact the credit card company(s) and workout a cash settlement for hardship and then come down to an exact amount that is needed to settle and payoff. Then only look to withdraw the lowest amount possible and whatever is left, transfer to a new IRA and start rebuilding it with the monies you would have spent on credit card payments.

Expert:  Patrick O. Oswald replied 2 years ago.
18% on 50k is almost 10k/year. As such the 10% penalty doesn't look so steep. In addition depending on the restrictions in these accounts yo may not be able to generate an above market return. If you pay the debt off you will have to plow additional funds into your retirement account to make this up depending on your age... I would say the break-even rate is @ 12%. Anything over that and I would consider paying down the debt with the retirement funds.

You could also go to a bank or credit union and see if you could consolidate the credit card debt and pay 1 payment at a lower rate... unfortunately most people run the cards up again.. I hope you can prevent yourself from doing this...

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