This Controversial Reddit “Mistake” Could Jeopardize Your Retirement Nest Egg

So you’re saddled with debt from credit cards, student loans, medical bills, etc. And every month, you watch as interest accumulates in the form of more debt, while your retirement savings plan carves a dent in your paycheck. Staring at your 401(k) or IRA balance, it may seem counterintuitive to keep money aside while struggling to pay down debts.

You’re not alone. Dozens of Redditors every day ask this question: “Should I withdraw from my retirement savings account to pay off my debt?” 

While eliminating debt by tapping your retirement funds would bring immediate financial relief, it can jeopardize your future financial security. Here’s why this action is likely a big financial mistake:

Short-Term Solution, Long-Term Impact

Though paying off high-interest debt will save you money in the long run, you must also consider the loss of potential with your retirement account. What saves you $1,000 in interest this year may cost you $100,000 in future investment growth by the time you retire. 

Additionally, early withdrawals can trigger penalties and taxes, reducing the amount you can use to pay off your debt. For 401(k)s and traditional IRAs, if you withdraw before age 59½, you’ll owe income taxes on the amount withdrawn, along with a 10% early withdrawal penalty. In some situations, such as a medical emergency, you can avoid the penalty—but never the income tax. 

Roth IRAs offer a bit more flexibility, allowing you to pull your contributions tax-free and penalty-free at any time so long as you’ve owned the account for at least five years. And, if you withdraw funds from your 401(k) due to financial hardship, you may be prohibited from contributing to your account for at least six months, further restricting you from rebuilding your savings. This can be particularly detrimental if you’re unable to take advantage of employer matching during this time. 

Penalty-Free 401(k) and IRA Withdrawals

Early withdrawals are typically subject to a 10% penalty, but there are some circumstances where the fee can be avoided. You’ll need to demonstrate an “immediate and heavy financial need,” according to the IRS. That includes: 

• Certain medical expenses
• Certain natural disasters
• Costs related to the purchase of your primary residence
• Tuition and other education-related expenses
• Payments necessary to prevent eviction or foreclosure on your primary residence
• Funeral and burial expenses

Even in these cases, income tax still applies. 

The Bottom Line

Raiding your retirement account to pay off debt is generally a bad idea. Early withdrawals can stunt your investment growth, leaving you with a smaller safety net when you retire. While debt can feel debilitating, there are other options available to you. Instead of emptying the account, you can try reducing or pausing your contributions and instead divert those funds to paying down debts.