Use your retirement money to avoid foreclosure?
It's become far too easy to shuffle money around without thinking about the tax consequences or the long-term savings consequences. And this option is absolutely terrible in both of those regards. While many retirement plans do have provisions that let your borrow from or cash out of your retirement account to avoid foreclosure, it can be expensive.
Borrowing against your retirement fund is a better option, because it doesn't create any tax consequences. But it's not free money -- you have to pay it back to the retirement fund with interest. And of course, you're losing out on the interest, dividends, or increased fund value you could have gotten while the money was in the retirement fund.
Cashing out of the retirement fund is a worse option. Under the IRS rules, you might be able to get a hardship distribution to prevent a foreclosure. But the rules for these vary, and even if you do get to take such a distribution, you'll still have to pay regular income taxes on the amount you take out.
If you don't qualify for a hardship distribution, any money you cash out is taxable and usually has a penalty associated with it. By the time you pay all state and federal taxes and penalties related to cashing out early, you typically lose about 50% of what you cashed out. That's a bad deal all the way around.
Weigh your options carefully before taking money out of a retirement fund to avoid foreclosure. You might also consider selling your home. Sometimes that's the best bet to help dig out of a bad financial situation.
Tracy L. Coenen, CPA, MBA, CFE performs fraud examinations and financial investigations for her company Sequence Inc. Forensic Accounting, and is the author of Essentials of Corporate Fraud.