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I am 38 years old and married. Because of a mix of bad luck (multiple lay-offs between my husband and I over the years which led to months of unemployment, unexpected major medical bills), choice (job change years ago led me to switch careers by going back to school and not working for a year) and bad mistakes (lots of credit card spending...mostly just to "survive", but sometimes just frivolous spending), we have acquired a massive amount of credit card debt.

We currently make $115,000 combined gross income (this has just recently increased due to my fortunate job promotions over the past 3 years). 3 years ago we were only making $75K combined and 5 years ago we were making $30K combined. So, I'm very proud of where we are now.

But...back to the problem. We have $65K in credit card debt. I am very strict with our budget but the last year has proven to me that getting that debt down is just not working. We are only paying the minimum on the 11 cards we have for a total of $1500 a month in minimum payments. Our income per month is exactly equal to our expenses. We are so extremely stressed and it's been like this for years.

I never, ever considered doing this until now but I really, really think it's the best way to get debt free and get out of this hole. We are considering cashing out our IRAs and 401Ks to pay off this credit card debt. We currently have $70K in these investment funds. If I'm doing the math correctly we would have about $40K after tax penalties to pay off most of this $65K debt (we would only withdraw $60k of the $70k of investment funds in order to stay within 25% bracket...see below about that).

Every Feb we receive $4K in bonuses and about $2K in taxes so we would be able to pay off the remaining $25K in 2 years (because we would also be able to pay $500 per month toward the $25K because of the $1000 of month savings we would have by paying off the $40K). After the credit cards are completely paid off we will have at least $1500 a month and can really focus on quickly saving for retirement. Currently we aren't even investing in our 401Ks because we can't - there is no extra money for it and I don't see that changing any time soon because there is just no extra money at all. Let me also add that we also have $15K of personal loans and $20K of auto loans which equal $1100 a month in payments. I have $45K in student loans which I have been deferring for years now and next April I have to start paying on ....no more deferment allowed. That will be $400 a month. We also have $50 in savings and that is it. That really, really makes me very nervous.

It's all a mess, I know!!! I need some kind of reassurance that we are making the right decision to do the early withdrawal. I know most people will say it's a stupid thing to do, but I truly feel it's our best choice. I will not consider bankruptcy. And we are not going to sell our house or cars. There is no more cutting of expenses.

A couple of questions:

  1. We are currently in the 25% tax bracket. I was thinking we could make one withdrawal before the end of this year of $30K and still stay within the 25% bracket and then early next year make another withdrawal of $30K to again stay within the 25% bracket. At least by doing two separate withdrawals we are avoiding the 28% bracket and saving a little of money. I also am aware of the 10% penalty. Am I thinking correctly and can I do the 2 separate withdrawals?
  2. Is there anything else I'm missing? How would the withdrawal affect my taxes on my regular income or would that just remain the same? In other words in Jan when I do my taxes I'm assuming I would just show that I made $145K for 2014 (our $115K income and the $30K withdrawal) and we would be taxed on that.

Oh - and it goes without saying - we are through with credit cards. If we don't have the cash, we will not be going on that vacation or buying that product. It's just how it is. Thanks for any advice!!

Edit --- All very good points. Yes we have accumulated quite a bit more expenses just recently. My daughter just started attending private school in the last year and we pay 500 a month. Prior to that we paid nothing for daycare. Also we purchased a car for me a year ago which is 375 a month. Probably shouldn't have done it but the car I was driving was on it's last leg. I hadn't purchased myself a car in 10 years and hadn't had a car payment for 7 years. I thought about the 401k loan idea. Honestly it just sounds so wonderful to be nearly debt free and to have 1500 a month extra to not have to pay credit cards and that is why the ira withdrawal is oh so appealing. I'm so sick of this debt (I know it's my fault). The 401k loan is an option. Only problem is that my husband and I have worked less than 3 years at our jobs and haven't accumulated very much in the 401k. He has 13k and I have 9k. But - we do have 45k in iras. Last night I did some research and read about reverse rollovers which I hadn't heard of before. Do you all know much about it? That is - rolling over the ira money into our 401ks. If we can do thag and take out 50 percent we could get app 35k to use toward our debt which would be great. Instead of 1500 a month we would spend about 1050 a month (630 from the 401k loan and 425 for the remaining credit cards). Not sure if I would be able to do that at work. I work for the fed goby and I doubt they allow a reverse rollover. Honestly though I'm still very tempted to just cash out all of the iras and 401ks and just pay off 40k of the debt and only pay 425 toward credit cards per month instead of 1500 (or 1050 by the 401k route). Thoughts??

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    If your income is equal to your expenses now, what were you doing 3-5 years ago when your income was only $30K? It seems you either had lower expenses, or would have accumulated even more debt than you have. You say your income has increased roughly by a factor of 4 in the past 5 years; have your expenses really quadrupled as well? – BrenBarn Oct 14 '14 at 6:07
  • Have you considered talking to a lawyer about doing debt mediation? It will hurt your credit rating (though not really that much), but if you're done with credit cards and don't need great credit for anything else, this might be one option. In some cases, you can actually make money off the process, as many collectors violate collection laws. Note: if you do this, talk to an actual lawyer, not one of those non-lawyer firms that advertises they can reduce your debt. – barrycarter Oct 14 '14 at 17:14
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    When you cash out the retirement accounts you'll owe taxes and penalties--you won't have anything like the money that's in them to apply to your credit card debt. There's almost no situation where cashing them out makes sense. I think you need a detailed budget and figure out what you can do about your financial situation. – Loren Pechtel Oct 14 '14 at 19:57
  • You make a good income, and I question that you have done all you can to cut expenses. I think you'll need to do much more, with $145K of debt. What is your mortgage payment? Have you drawn up a written monthly budget that lists all of your expenses? – Ben Miller Oct 15 '14 at 1:57
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If your credit card's interest rates are not more than your 35% (25% for your tax bracket and 10% penalty), there is no way I would consider this.

If you boil it down to the numbers, you are asking whether you should borrow money at a 35% interest to pay off your credit cards. I would say Absolutely Not!

$20K of auto loans which equal $1100 a month in payments.

Also we purchased a car for me a year ago which is 375 a month. Probably shouldn't have done it but the car I was driving was on it's last leg.

Where is the $805 difference going? You've got to make sacrifices, and right now you are leaning towards sacrificing your future for your present. It would take years of Large Contributions to make up for the money lost in early withdraw penalties and taxes, not to mention the loss in growth these accounts would have been earning if left alone. This plan is similar to saying you want to spend $60k to pay off $40k. Don't do it!

If it was me, I'd get a couple $3,000 cars. That should free up at least $600 a month and reduces your debt by $14k.

I'd also pull my child out of private school unless there is really no public option, which based upon your refusal to consider selling your house, I image there's a decent public school near your neighborhood. That's an extra $500 a month.

Next, I'd sell anything that I could through craigslist or garage sales.

I'd get on a written budget and the envelope system, to make sure you are really as 'tight' as you are presenting in your question.

Hating Debt is a great motivator, but you shouldn't let it lead you to make even bigger financial mistakes.

I think you started doing well and got promotions and did what almost everyone else does; you increased your standard of living. No matter what you choose to do, you will never build your retirement or have financial stability without living on a budget and spending less than you make.

Maybe attacking this debt the old-fashioned way will give you the tools you need to gain financial stability long-term.

Updated to address calculations

Assuming 18% CC interest and 10% IRA Growth. And always spending at least $1500 on CC debt until it's gone, then $1,500 back into retirement after that.

If you continued paying $1,500 a month the credit cards would take about 71 months to pay off. In that time, you'd spend a total of $106,500 on the debt.

Your plan would spend $60k upfront to reduce the debt by $40k. The new balance of $25k would be paid off in 20 months and would cost $30k total. Total cost on your plan would be $90k. Your plan pays $16.5k less in total, and it would be 51 months quicker. However, you would have no retirement at age 40.

If you then saved $1500 a month in retirement, you would catch up to the $70k loss in your IRA at age 49 (I'm including growth in both accounts to calculate this).

If you had instead just left the IRA alone, you'd be done with the CCs at age 44. If after age 44, you put in $1500 month into retirement your plan would never catch up to this plan. It seems to me that cashing out your IRA is a 5 year detour.

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    If unpaid, a $1000 balance on an 18% card will double in 4 years, growing to $4000 in 8 years. The 35% tax and penalty is not a 35% interest rate, it's a one time cost. I agree with the rest of your response, but this math is a bit off to me. – JoeTaxpayer Oct 31 '14 at 2:06
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    Agreed, I added some additional calculations to clarify. I'm trying to use different ways of describing the error in hopes of helping her make an informed decision. The interest rate comparison is a simplification. A $40k loan at 18% payed back at $1500 a month would take 36 months. And you'd pay $51k total. So getting $40k after $20k in penalties is at least worse than that. – Kaizen Programmer Oct 31 '14 at 15:16
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    I reversed my down vote. Welcome to my world, trying to explain what you know to be true, in a way that's not too dry, and not confusing to the reader. Good edit, Mike. – JoeTaxpayer Oct 31 '14 at 16:33
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    @JoeTaxpayer Thanks. It's definitely not easy. – Kaizen Programmer Oct 31 '14 at 18:36
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    @Rocky I personally don't think debt consolidation will make a big difference in the overall numbers. Getting extremely focused and paying it off as fast as possible will have the biggest impact. Most people use the money 'freed' from debt consolidation on lifestyle and don't actually change their habits. Any reduction in interest will be fruitless if not matched with intense budgeting and sacrifices. But if she can remain focused after consolidation it helps the numbers some. But personal finance is not really about the math in my experience. It's behavior-driven. – Kaizen Programmer Nov 1 '14 at 21:43
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Am I thinking correctly and can I do the 2 separate withdrawals?

Yes.

Is there anything else I'm missing?

Yes. For starters - instead of withdrawing 401k - why don't you take a loan out of it? This can be dangerous, but also can be beneficial - both for the same reason.

The beneficial part is this: you don't pay neither the income tax nor the penalty on the amount you take out as a loan. I.e.: immediate saving of 35%. You can also get the full loan amount (up to 50% of the 401k balance) at once, no need to wait for the next year. You'll be saving on the difference on the APR between the credit card debt (which is usually huge) and the 401k loan (which is usually very low), and that will allow you to consolidate the debt and cover it quicker.

The dangerous part is also taxes. In case you lose your job - you have to pay off the loan immediately (within 3 months). If you don't - the remaining balance will be considered as a taxable distribution and you'll owe the 25%+10% on them.

But - if you don't lose your job, you win. And repaying the loan will revert your 401k balances back to the full amount, while with withdrawal - you cannot put it back (after 60 days are over, at least).

So keep that in mind. Check with your 401k plan provider on the loan terms and costs (they'll charge some symbolic amount for managing the loan for you).

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    I'd only add - if they have the ability to transfer the IRA money to the 401(k)s, i'd do it. Better to borrow $5k from $10k in the 401 than to be left with $6500 after tax and penalty. – JoeTaxpayer Oct 14 '14 at 4:30
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    I agree with all of this, but you should also remember while you're saving the 35%, you are costing yourself whatever growth you would've had, plus the compound gains on that; so 8%, say, if you're earning market averages. It's not entirely free. – Joe Oct 30 '14 at 22:48
2

Financial problems are often due to budget (income statement) issues, either caused by excessive expenses or too little income. You state your income at $115K (pre-tax?), which is much larger than median income. But you do not supply (all) expenses, other than state that you have debts that require large payments, and that you are doing well budgeting (which is hard to accept based upon the large debt load).

Though you do not mention specific card amounts, interest rates, and options you have considered for addressing these balances, you do suggest that you understand the problem, and want to pay the credit cards off.

  • credit cards, $65K (11 cards)
  • personal loan, $15K
  • auto loans, $20K (2?)

You have a large amount of debt comprised mainly of large credit card balances. There are no easy solutions for high credit card debt. This is a problem that you need to learn how to manage, and the costs that you incur when you allow easy credit to chain you to service to the credit card companies.

Rather than sacrifice your future, look to finding ways to fix your present situation, which is tough. Try to find a way to dig out of the debt, which will take several years. Lets put this debt in perspective - consider that a five year (60 months) plan to repay the debt will require paying > $1000/month towards principal (plus the interest on all the cards). Difficult, but not impossible. You also mention two cars, with $375/month on one car, $unknown/month on the other car. Plus you mention $500/month for private school.

Since the debt is a balance sheet problem, do you have any assets you can sell to payoff some of the debt? Can you sell your cars and obtain cheaper vehicles that have smaller payments? Can you examine you budget and find areas where you can save? When you were making $75K/year or $30K/year, you certainly had lower expenses and a smaller expense budget - can you reduce your expenses to a more modest level? Can you go on a 'budget diet'? This would be the advice Dave Ramsey (and others) would give.

You probably have $6400/month income (net after taxes), which using the LearnVest approach would give you three budget categories. Modify the approach to allocate more for financial priorities (paying down debt) until you have the credit cards under control. I have estimated below,

  • Essentials (50%, $3200)

    • rent/mortgage - less than $1500
    • utilities - $500
    • transportation - (< $650/month, pmts, fuel, insurance, maint)
    • food $500
  • Financial (30%, $1920)

    • credit cards ($1500)
    • personal loan ($200)
    • excess auto payments ($375)
    • student loan payments
  • Lifestyle (20%, $1280)

    • cable
    • cellphone
    • internet
    • entertainment/dining out
    • tuition

Some suggestions,

  • sell/trade one car for a cheaper car, rideshare
  • move to a cheaper apt? reduce rent? move in with parents?
  • sell some posessions to payoff a credit card?
  • cut back on your cable and/or internet bill (limit to $100)
  • cut back on you cellphone bill (limit to $100).
  • limit your entertainment/dining out to $200/month
  • cancel the gym membership
  • eat more frugally

The Debt Snowball approach works. Driving a cheaper car works. Scaling back on monthly lifestyle expenses works. Slash your expenses for a year - cut back on everything, and pay off some of that debt. You really need to manage this situation with a focus on reducing that unsecured debt to a manageable level.

Consider a reputable debt repayment plan.

0

I'll add a little to the already great advice here.

It certainly sounds like you are in need of consolidation here. Having 11 different cards vying for your attention sounds like a nightmare to manage.

I also concur that it is a bad idea to cash out your retirement accounts to deal with this. I know it's frustrating to have the debt hanging over your head (I have student loans I'm personally working on) but getting a loan to consolidate that level of noise sounds like a much smarter move that can help greatly if you have high interest cards (most likely the case here).

Since you mentioned that you are not interested in selling the house, have you considered a home equity loan to consolidate this?

Best of luck to you.

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Some of the expenses you describe may be eligible to be paid off by a 401(k) without incurring a penalty. As long as you do not mind paying tax on the extra income. If your tax bracket does not go up, then using your IRA may not be a bad idea. You should consult a tax expert and see which expenses can qualify for a withdrawal without penalty.

I believe medical bills and medical insurance costs are eligible to be withdrawn without penalty in some instances.

  • In very rare instances when they're above the 10% AGI threshold. Medical insurance is not included, as it is not deductible at all. Only medical expenses above the 10% AGI limit qualify. – littleadv Dec 8 '14 at 23:39
  • investopedia.com/articles/retirement/02/111202.asp 2. Medical Insurance If you are unemployed, you may take penalty-free distributions from your IRA to pay for your medical insurance. In order for the distribution amount to be eligible for the penalty-free treatment, you must meet these certain conditions. – Sun Dec 8 '14 at 23:54
  • You're right. However, it is irrelevant to the OP, since the amounts had been paid a long time ago. Now we're dealing with debt, which the insurance premiums while unemployed might have contributed to - but cannot be used to cover it. See IRC Sec. 72(t)(2)(D) for details. – littleadv Dec 9 '14 at 0:32

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