Expert: Paul Sid, CPA CFA - 2/4/2012

Question
Hi,
I'm 35 and currently unemployed after a 12 year run at a fantastic company.  I left for what appeared to be a better opportunity, and it wasn't.  During my 12 years I accumulated about $48,000 in my 401k.  Right now, my debt totals about $20,000, including small credit card debt and large student loan and car payment debt.  I included paying off the car completely and the student loan completely in that number.

Does it make more sense to withdraw half of my 401k, which I believe I can since I've lost my job and have no income, or do I continue with monthly payments and minimum payments and ignore the 401k?

When I finally get a job, I will continue contributing 10% of my salary to my 401k.

Any ideas?

Thank you!

Darcy

Answer
Hi Darcy,

Thanks for your question.

One of the objective in financial planning is to establish an emergency fund.  That was not done - but that is water over a dam.

In general, I am not fond of the idea of using your 401(k) funds to pay current expenses.  You are in effect creating a future problem -- that is to reduce funds needed at retirement.

At age 35, retirement is far in the future.  But when you're 65 you will be revisiting the decisions you've made today at age 35.  Let's put those nasty thoughts aside and focus on your question.

Your question- should you dip into your 40k(k) plan to pay off a $20,000 debt?  In other words will you be financially ahead in 2012 with a debt payment?

Answer - probably not.

Current assets before payment = 401(k) - debt = 48,000 - 20,000 = 28,000
Current assets after 401(k) payment = 401(k) - debt = 28,000 - 0 = 28,000
Under either approach your current asset is similar -- $28,000.

Senario #1: Cash flow "WITHOUT" use of 401(k)
- minimum payment of debt ~ 0
- additional interest on outstanding debt (assuming 10% interest rate) = 10% * 20,000 = 2,000
- income taxes = 0
- Total cost if you don't use your 401(k) = 2,000

Senario #2: Cash flow "WITH" use of 401(k)
- full payoff of debt
- additional interest on outstanding debt (assuming 10%) = 10% * 0 = 0
- income taxes penalty on early withdrawal = 10% * 20,000 = 2,000
- income tax on the 401k withdrawal (assuming that you find a job in 2012; using a 25% tax rate) = 5,000
- Total cost of withdrawal = 7,000 (2000+5000)


Summary.

1. Whether you use or don't use your 401(k) you net assets is the same ($28,000; ignoring interest built-up on the $20k debt, which could be large).
2. Senario #1.  If you don't payoff your debt, the balance continues to grow.
3. Senario #2.  If you payoff your debt with 401(k) money and you find a new job, the cost could be expensive- $7,000 or more in my estimate.  Furthermore where will you get the $7,000?  By further dipping into your 401(k)?

You have a difficult problem.  Either choice is unfavorable.  We're in early February.  Personnally I suggest that you tough it out for a few more month and focus on finding a new job.  Move if you have to.  Take less pay if you have to.  In the end having a new job is your better solution.

I hope my input provides you additional informaton as you make your financial decision.

I wish you much success in your job search.

Regards,
Paul Sid, CPA CFA