Dave Ramsey says: Don't cash out on 401(k), emergency savings to pay off student debt

Published: Monday, Nov. 26 2012 2:33 p.m. MST

Dave Ramsey says it's a bad idea to withdraw from 401(k) plans or emergency savings to pay off student loans

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Dear Dave,

Is it a good idea for a married couple in their early thirties, who have a lot of student loan debt, to cash out one of their 401(k)s to pay it off?

Marcy

Dear Marcy,

No way! You never cash out a 401(k) or IRA to pay off debt, unless its to avoid a foreclosure or bankruptcy. Lets say you take $50,000 out of your 401(k). Do you know what happens next? Theyre going to charge you a 10 percent penalty, plus your tax rate. If you make $75,000 a year, that puts you in a 25 percent tax rate, plus the penalty. Thats a 35 percent hit, and thats how much of your money is going straight down the toilet.

Look at it this way. You wouldnt ask me if its okay to borrow money at a 35 percent interest rate to pay off your school loans, right? That would be ridiculous, and this is just as dumb.

There are no shortcuts when it comes to getting out of debt, Marcy. Roll up your sleeves and get on a beans and rice budget where every dollar has a name. This will enable you to save money and pay off that debt!

Dave

Dear Dave,

My wife and I have our fully funded emergency fund in place, and were debt-free, except for the house. She wants to return to school to get a masters degree and change careers. Shell be reimbursed up to $7,000 a year. Can we use some of our emergency fund to get things started?

Kevin

Dear Kevin,

Ive got a better idea. Save up the money!

You guys are in great shape already. And to me, this opportunity seems like a small investment with a fabulous return. I really like the idea. But you have to be careful when it comes to things like this. You dont want to get into the habit of calling things emergencies when theyre not emergencies. Its a great thing, but its nowhere near an emergency.

I know shes excited about the possibilities, but Id just roll up my sleeves, save a little extra for a while and cash flow the classes. Shell probably get reimbursed for the first classes right after she gets her grades, then you can use the reimbursement check to pay for the next classes, and the next check the next classes. Make sense?

I love the school idea, and Im glad your wife has such a great opportunity. But I dont want you to take a chance on messing up the progress youve made in taking control of your finances. Just take your time and save for those first classes. Youll be glad you did!

Dave

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