How big a burden is debt for 18- to 34-year-olds? A new study, "Merrill Lynch/Age Wave: Early Adulthood: The Pursuit of Financial Independence," found that of the more than 2,700 people polled, one in four have withdrawn from their 401(k), primarily to pay off student loan and credit card debt.
But robbing Peter to pay Paul has consequences. Pulling out money “from your 401(k) is a bad idea,” says Brian Brandow, of Ronkonkoma, who runs the website DebtDiscipline.com.
Know that you may not be able to afford to contribute additional money to the plan while you’re trying to replace the money you withdrew. Because of that, you'll not only not add that money to your account, but you'll also miss the benefit of making pretax contributions to your account.
On top of that, “if your employer matches contributions, you won’t receive that, either,” says Lawrence Solomon, a certified financial planner with Mercer Advisors in Vienna, Virginia.
Do the math
In addition, “you face a 10 percent penalty for early withdrawal," when you take money out of your account before you're retired, says Marissa Sanders, a financial expert with SimpleMoneyMom.com. "So that $11,000 that you took out now becomes only $9,900. Second, you must report it as income on your taxes. This money becomes taxed. After penalties and taxes, you only end up with $6,600 in the end.
"So is it worth it?" asks Sanders. In her estimation, the answer is no: "Don’t pay off debt with your retirement account,”
The longer you save, the more you’ll have later, thanks to compounding interest. But time works against you when you withdraw from your 401(k).
“When running a race, how productive is it to get halfway, then go back to the beginning to start over?” says John Grace, president of Investor’s Advantage Corporation in Westlake Village, California.
Radhika Mehta-Sharan, a wealth management adviser for Merrill Lynch in Manhattan, advises, “Think of your 401(k) like a pension — it’s something you can’t access until retirement.”
An earlier version of this story misstated the name of Lawrence Solomon's company. He is a certified financial planner with Mercer Advisors.