As with any major financial decision, you have to weigh the pros and cons of withdrawing from your retirement account to clear a debt. The withdrawal may bring a number of tax implications, especially if you're not yet 59 1/2. Depending on the type of account it is, how much you withdraw and why, you may face a 10 percent early withdrawal penalty or be bumped into a higher tax bracket.
Make sure your particular retirement account allows withdrawals. For example, a traditional or Roth IRA allows you to remove your money at any time, provided you're willing to pay any tax or penalties that apply. At the other extreme, a defined-benefit pension plan does not typically allow you any withdrawals.
Compile the latest statements from the creditors you wish to pay off in addition to your most recent retirement account statement.
Add up the total amount of debt you wish to pay and compare that to the amount you have in your retirement account. Depending on the type of account it is, the total balance may include some money -- such as an employer match -- that you are not eligible to withdraw. Be sure you are looking only at the money available to you for withdrawal.
Determine if you qualify for an exception to the early withdrawal penalty. Again, depending on the specific rules associated with your particular type of account, certain situations -- such as medical bills or a first-time home purchase -- may allow you to avoid any penalties.
Contact your plan manager and request an early withdrawal. If you have any questions about the process, fees or tax implications, now is the time to ask.
Complete the necessary paperwork indicating the amount you wish to withdraw. Return it to your plan manager. Depending on your plan manager, you may also have to pay a fee. This will vary by company. You will receive the funds within an allotted time frame, typically within a week.
Pay your debt with the proceeds.
- Consider other alternatives before touching your retirement funds, such as a loan, a credit management plan or a second job.
- At the end of the year, your plan manager will send you a 1099-R reflecting the funds withdrawn from your account. You must report this income appropriately at tax time, and pay any taxes or penalties due.