Should You Use Your IRA Rollover for Debt? Read This First

If you’ve rolled your retirement savings into an IRA, you might have experienced a feeling of “plenty” – or at least a feeling of having a decent amount of money on hand. This can give rise to the question: should you use some of those savings to pay down debt?

The answer, of course, depends on your personal financial situation and needs. Here’s what we suggest you consider before making any decisions.

What to take into account

 There are five key factors we recommend thinking through before drawing down retirement savings for debt:

  • The most basic calculation of value
  • The type of account (Roth vs. Traditional IRA)
  • Your age
  • Your tax situation
  • Your current and expected financial situation

Let’s examine each of these in more detail.

The basic calculation

At heart, deciding if something like this is worth it is a math problem: compare the cost of the withdrawal to the cost of maintaining your debt status quo. Remember, pulling money from a retirement account means less savings today, but it also means less growth in those savings over time.

We recommend using the total cost your debt (including interest) and sizing it up next to the potential dollar growth of your funds as a basic point of comparison – it can be tempting just to compare interest and growth rates, but we find it’s useful to put it in dollar terms to help make sure you’re getting an apples to apples comparison.

But there are some other possible costs you may want to keep in mind as well.

Type of account

This typically applies to Roth and Traditional IRA accounts. Because Roth accounts are funded with after-tax dollars (i.e., you don’t get a tax deduction for your contributions), you don’t have to pay income taxes on your withdrawals. This can make the Roth potentially attractive source of funds.

On the other hand, Traditional IRA accounts are funded with pre-tax dollars, meaning you will need to pay income taxes on any withdrawals in retirement. In this situation, you would likely want to account for the cost of income taxes before drawing the money to pay down your debt.

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Age

If you’re below the age of 59½, you’ll want to account for the potential cost of penalties on any IRA withdrawals. In addition to any potential income taxes owed, making withdrawals from a qualified retirement account below this age will trigger a 10% penalty payment on the amount withdrawn.

You could be exempted from penalties if you meet certain requirements: namely, that the withdrawal is used for death, disability, qualified education expenses, and a few other specific areas. Please note that these exemptions apply only to penalties, and not to income taxes.

That said, if you’re younger than 59½, you may want to seriously consider alternative sources of funds.

Your tax bracket

Aside from considering the tax implications of a withdrawal, you might also want to consider whether your withdrawal will put you into a higher tax bracket. This could also impact the cost of using these funds to pay down your debt!

One of our clients, Jim, forgot to make this assessment prior to using his retirement savings to pay off a car loan. He says, “This is actually what convinced me that we needed professional financial advising (my wife had been saying this for years). I thought I was doing something smart, but then we got hit with an unexpectedly high tax bill at the end of the year!”

In other words, be careful about this possible cost – which may only come later!

Your financial situation

It can be useful to consider the big picture of your finances when weighing up these decisions.

If you’re not concerned about drawing income from your retirement accounts over the course of your golden years, you might feel more inclined to simply pay off your debts and not have to worry about them again. Similarly, high levels of high-interest debt can erode your financial situation to an extent that a large payment is the most prudent course.

But if that money needs to be counted on for later, you may want to consider alternatives.

What are my other options?

 When finding a way to pay off debt – high interest debt in particular – it can be useful to consider alternative sources of funds. For some borrowers, transferring balances to a low- or no-interest card can provide some relief, while others seek out low-cost personal loans.

You can also get creative: one couple we know found that an unexpected benefit of moving was the proceeds from selling unneeded furniture and household goods – the money went to paying off the credit cards and they started retirement feeling a little richer.

Proceed with caution

 As with all financial decisions, there is no single answer that will work for everybody. Think about the amounts involved and about the possible implications for your finances – taking into account the hidden costs and fees that aren’t always so obvious at the outset.

Wondering what else you need to navigate in retirement?

 Aside from complex IRA rules, another common sticking point for financial planning is life insurance. Whether it makes sense for your situation or not depends on a number of factors, but getting through the alphabet soup of options can be overwhelming.

Download our free guide to life insurance, which will walk you through common policy structures and where they might fit into your life.

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​Your Life Insurance Guide

The Basics on Life Plans

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Let Us Help!

We can discuss this topic and more at a complimentary appointment. As a bay area retirement planning coaches, we can give you a review and make suggestions based on your retirement objectives.

Important Disclosures

The opinions voiced in this article are for general information only. They are not intended to provide specific advice or recommendations for any individual and do not constitute an endorsement by United Planners.

To determine which investments may be appropriate for you, consult with your financial professional. Please remember that investment decisions should be based on an individual’s goals, time horizon, and tolerance for risk. Neither diversification nor asset allocation can ensure a profit or prevention of loss in times of declining values. United Planners does not render tax advice.

Securities and advisory services offered through United Planners Financial Services, member FINRA, SIPC. Pasquale Vitucci, CA Insurance Lic. # 0758212, is an Endorsed Agent of Vitucci & Associates Insurance Services CA Insurance Lic. # 0I06319. Vitucci & Associates Insurance Services and United Planners are separate and unrelated companies.
This page contains links to third-party company websites. By selecting a link, you will be leaving our website and launching a new browser window. These links are provided for informational purposes only and should not be viewed as an endorsement, sponsorship, solicitation or other affiliation with respect to any third parties. We are not making any recommendations or providing any advice on securities in particular or investments in general. Neither Vitucci & Associates nor United Planners Financial Services have reviewed the content of, and are not responsible for, the information or the results of the third-party websites.

Further Reading

IRA withdrawal rules: https://www.irs.gov/newsroom/what-if-i-withdraw-money-from-my-ira

Traditional IRA tax rules: https://www.irs.gov/retirement-plans/traditional-iras

Roth IRA tax rules: https://www.irs.gov/retirement-plans/roth-iras