Dave Ramsey: This Is the Only Reason You Should Cash Out Your Retirement Fund Early
When you’re struggling with debt, withdrawing money from your retirement account can seem like the perfect solution. But Dave Ramsey, author, radio show host, and personal finance expert, cautions against it — except in one particular situation.
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Keep reading to learn why Ramsey believes withdrawing from your retirement early is almost always a bad idea.
Should You Withdraw From Retirement To Pay Off Debt?
According to Ramsey, you should almost never take money out of a 401(k) or IRA — even if you have a ton of debt.
The reason? Early withdrawals have steep penalties. For example, if you withdraw from an IRA without a valid reason, the IRS will charge you a 10% tax penalty. Plus, the amount you withdraw may be included in your gross income, increasing your tax bill.
You’re also stealing from your future self when you withdraw from a retirement account — not just the money you remove from the account, but also the growth you miss out on as a result. Because of this, Ramsey says the only time you should ever think about taking money from a retirement account is to avoid bankruptcy or foreclosure
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Rules for Early Retirement Withdrawals
Retirement accounts like IRAs and 401(k)s offer tax advantages that make it easier to save for life after your career. However, the IRS discourages drawing funds before retirement by hitting those who do with penalties.
Still, there are a few cases in which you can withdraw funds from an account early without any fees — even though Ramsey cautions against it. You’ll find a closer look at the rules for IRA and 401(k) early withdrawals below.
IRA
Generally, you’ll get hit with a 10% tax penalty if you withdraw funds from an IRA before you’re 59.5 years old. But there are exceptions. You may be able to withdraw funds without any penalty if you’re doing so for a qualifying reason. These include:
Using your IRA funds to pay for health insurance after losing your job
Spending up to $10,000 on a first-time home purchase
Spending up to $5,000 on birth or adoption costs
Paying qualified education expenses
Paying costs related to a death, disability, or terminal illness
401(k)
Withdrawing from a 401(k) early will typically leave you with a 10% penalty as well. You’ll also have to pay taxes on whatever you withdrew, which could bump you into a higher bracket.
This makes it really expensive to withdraw from a 401(k) before you retire. That’s why Ramsey says you simply shouldn’t do it unless you really have no other option and are facing bankruptcy or foreclosure.
Nonetheless, there are a few special cases when you may be able to withdraw early without facing penalties. These include:
Withdrawing an amount you overcontributed to your 401(k)
Leaving your job at age 55 or later
Having your 401(k) divided in a divorce
The IRS also allows penalty-free hardship withdrawals. However, these are only allowed for people with specific, immediate financial needs. For example, you might qualify if you need to repair your home from a natural disaster.
What Ramsey Says About Retirement Account Loans
You might think of temporarily borrowing from your retirement account as an alternative to an early withdrawal. But Ramsey warns that you should never to do this, either.
The key reason is that you can’t borrow your way out of debt. You’ll always have to pay your future self back — with interest. Plus, if you lose your job, a 401(k) loan becomes due in 60 days. If you can’t make the deadline, you’ll face the same 10% tax penalty.
Missing out on compound growth is another reason to avoid retirement account loans.
Getting Rid of Debt Without Pulling From a Retirement Account
So what should you do about your debt if you can’t pay it off with your retirement account? Here are some steps to get you started.
1. Cash Out Other Investments
If you have any investments outside of a retirement account, you can cash those out to pay down your debt. Assets like gold, stocks, and certificates of deposit (CDs) are all great candidates for this.
It may hurt to sell off your favorite investments, but your debt costs money every day in the form of interest. You need to pay it off to move forward.
2. Create a Budget
It’s impossible to truly take control of your money without a budget. You need one to see where you’re at financially. Budgeting will also help you figure out what kind of financial sacrifices it’s going to take to pay off your debt.
Even if the results of your budgeting process aren’t pretty, this is an essential part of personal finance that can make a huge difference in your financial health in the future.
3. Use the Debt Snowball Method
Your budget will tell you the amount of cash you can allocate toward debt monthly. Once you figure that out, Ramsey recommends using the debt snowball method to start paying down your debt.
This involves paying off your debts in order of least to greatest. You start with the smallest debt you have, pay that off, then move on to the next smallest amount and so on.
Ramsey likes this strategy because it helps with motivation and momentum. It’s easier to stay committed when you get to watch old debt disappear from your credit report.
Final Take
Ultimately, Dave Ramsey gives a number of reasons why it’s a bad idea to use retirement funds to pay off debt — unless you’re facing bankruptcy or foreclosure. But there are other strategies you can use to eliminate debt and increase your net worth.
From cashing out non-retirement investments to creating a stricter budget, there’s always something you can do to take the next step forward. It may just take a little research to find the answer.
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This article originally appeared on GOBankingRates.com: Dave Ramsey: This Is the Only Reason You Should Cash Out Your Retirement Fund Early
