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?
No way! You never cash out a 401(k) or IRA to pay off debt, unless itís to avoid a foreclosure or bankruptcy. Letís say you take $50,000 out of your 401(k). Do you know what happens next? Theyíre 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. Thatís a 35 percent hit, and thatís how much of your money is going straight down the toilet.
Look at it this way. You wouldnít ask me if itís 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!
My wife and I have our fully funded emergency fund in place, and weíre debt-free, except for the house. She wants to return to school to get a masterís degree and change careers. Sheíll be reimbursed up to $7,000 a year. Can we use some of our emergency fund to get things started?
Iíve 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 donít want to get into the habit of calling things emergencies when theyíre not emergencies. Itís a great thing, but itís nowhere near an emergency.
I know sheís excited about the possibilities, but Iíd just roll up my sleeves, save a little extra for a while and cash flow the classes. Sheíll 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 Iím glad your wife has such a great opportunity. But I donít want you to take a chance on messing up the progress youíve made in taking control of your finances. Just take your time and save for those first classes. Youíll be glad you did!óDave
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