Should I Use My IRA to Pay Off Credit Card Debt?

Chloe Meltzer

November 03, 2021

Summary: Are your credit card payments out of control? Thinking about using your IRA to pay off credit card debt? Find out if it's a wise decision to use an IRA to pay off your credit cards.

If you are attempting to pay off debt, you know that every extra bit you pay towards that debt is a big help. Whether you are trying to pay off credit cards, car loans, or student loans, debt can creep up, and interest makes it larger.

Some people might look at their retirement fund as a way to get out of that debt. Although this might be tempting, it is not a great idea. Typically using IRA money early can mean a lot of withdrawal penalties and taxes. It can also jeopardize your future.

Understanding penalties for early IRA withdrawal

Also known as an Individual Retirement Account, an IRA is a wonderful way to build wealth for your future. The important part of an IRA is that it is supposed to be for your future and your retirement. This means that the only reason you should ever take money out of your IRA before retirement is to avoid bankruptcy or foreclosure. Otherwise, it may not be worth it.

Money is taken out of an IRA early, which means before 59.5 years of age, must be transferred with 60 days to a different retirement account. This is considered a “nontaxable rollover.” Otherwise, the government will not only take penalties but also taxes. Additionally, nontaxable rollovers can only be done once every 12 months.

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Standard IRA

Taking money out of a standard IRA before the age of 59.5 will require you to pay a 10% penalty. Although there will be no automatic withholding, you will need to pay federal and state income tax on the amount you took out. This will need to be done on your taxes.

Roth IRA

When it comes to a Roth IRA it is a bit of a different story. Because a Roth IRA uses after-tax dollars but grows tax-free, then you can pull out your contributions without any penalties or taxes. The only thing to be aware of is that you cannot pull out any earnings unless you are 59.5 years of age, and your account is over five years old. Otherwise, there will still be a 10% early withdrawal penalty along with the tax penalties.

Exceptions to an early withdrawal penalty

You will always be required to pay taxes on money taken out of an IRA before a certain age, but in some situations, you will not need to pay the 10% early withdrawal penalty. These exceptions include:

  • Death
  • Becoming permanently disabled
  • Money is used to pay medical expenses (must but at least 10% of your gross income)
  • In military and called to active duty
  • Used to pay an IRS levy
  • Divided into equal payments (known as SEPP). This essentially means you must take a specific amount from your retirement fund over time. It is also a method of early retirement.
  • Used for higher education costs, such as tuition, rent, food, or books
  • Used to purchase or build a first home, up to $10,000
  • Used to cover health insurance premiums for an unemployed person

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Other options to pay off debt

If you are in debt but do not want to cash out your IRA, then there are other methods to look into. For example, you can make a budget. It might seem simple, but making a written plan can be extremely helpful. By being more intentional with your money, you can pay off debts quicker, and account for every dollar that comes in and out. This can help you to avoid using the money in your IRA when life gets tough.

Another option is called the debt snowball method. Known as the fastest way to pay off debt, it gives you rewards as you pay off your debts. You begin with listing all of your debts from smallest to largest. First, you go for the smallest debt and attempt to at least pay off the minimum payments. Once this debt is gone, you can take that payment, and pay it on the next debt. As you continue to budget more for your debts, you will create a “snowball effect” and be able to eventually pay off your debts.

Rather than dip into your IRA, avoid the costs of early withdrawal. Instead, work with someone who can talk you through your options and help to get you on track. This might include a financial coach or debt counselor. Debt can seem scary, but losing your retirement is even worse. Take control of your future today and save your IRA.

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