Use TSP to pay off high interest credit cards?

Do Not Touch Button - shutterstock_119741476Q: Should I use money from my TSP to pay off high inter­est credit cards?

–Joseph, Colum­bus, Ohio

A: I wouldn’t rec­om­mend it.  As a mat­ter of fact, I’d even go as far as to dis­cour­age it.

Real Feel­ings
Don’t get me wrong, I get the issue.  On one hand, hav­ing a bunch of high inter­est rate debt can be a huge strain both finan­cially and emo­tion­ally – and you feel them in the here and now.  On the other hand, money you’ve set aside for retire­ment gen­er­ally can’t be used with­out penal­ties until you’re 59 ½ so it can be really hard to feel all warm and fuzzy about this money you might not get to use for decades.  Put the two together and rob­bing future Peter to pay cur­rent Paul can seem like a great idea.  But it isn’t.

Some Draw­backs
There are a lot of rea­sons why it’s usu­ally a bad idea to raid retire­ment funds for rea­sons other than retire­ment but here are a hand­ful of the big ones:

  • Taxes & Penal­ties – If you take a with­drawal from your TSP prior to age 59 ½, you’ll likely have to pay a 10% IRS penalty for tak­ing an early with­drawal in addi­tion to the taxes you’ll have to pay. The end result could be a loss of as much as 25–30% to taxes. That’s a big cut! And on a related note, this is only an option if your TSP is an old plan for you and not one to which you can make cur­rent contributions.

 

  • Loss of Growth Poten­tial – Another down­side to using retire­ment funds to elim­i­nate debt is that you lose the growth poten­tial on those funds.  This is true even if you take a loan from an active plan rather than cash­ing out an old one. Lost return com­pared to credit card inter­est rates may not be a big deal over the near term but cal­cu­late it for decades and it can be a huge loss of opportunity.

 

  • Vio­la­tion of Sanc­tity – Once you step on to the slip­pery slope of using retire­ment money for other pur­poses, it’s all too easy to do it again. And while this might pro­vide some type of short-term relief, it cre­ates the risk that you’ll never be able to quit work­ing because you won’t have any money to sup­port you if you do.

 

  • Treats the effects, not the cause – I often refer to the idea of using retire­ment funds to pay off debt as putting a ban­dage on a bul­let hole. While it might cover up the bleed­ing, it doesn’t deal with the rea­son the blood is there in the first place. Con­se­quently, it’s likely to con­tinue.  In other words, if you don’t fix the under­ly­ing sit­u­a­tion that caused you to end up in debt, it’s often only a mat­ter of time before you’re sink­ing in it again but this time with no assets left to help get you out.

 

A Bet­ter (But Slower) Path
So my sug­ges­tion would be to take a dif­fer­ent direc­tion. Rather than focus on your retire­ment funds to get your head back above water, I’d focus on your income and expenses instead. On the income side, find more of it if you can.  Even get a sec­ond job or sell things if you have to.  And on the expense side, find ways to cut them.  Some­times this will be an easy exer­cise but other times it will require some very dif­fi­cult choices.  Either way, the goal is to free up cash that you can use to both build an emer­gency fund and knock down your debt. This approach will cer­tainly take longer than cash­ing out retire­ment funds but it nicely han­dles all of the draw­backs I’ve out­lined above.  Plus, it’ll help you build good habits that can ben­e­fit you for a lifetime.

Thanks so much for your ques­tion.  I hope this helps and I wish you all the best!

Scott

Share |

USAA or its affiliates do not provide tax advice. Taxpayers should seek advice based upon their own particular circumstances from an independent tax advisor. The information is provided for informational purposes only and is not intended to substitute for obtaining professional financial advice. Please thoroughly research and seek professional representation before acting on any information you may have found in this article. This article is in no way attempts to provide advice that relates all personal circumstances.

Examples given are hypothetical illustrations and not an indication of the benefits or features of any USAA product. You should seek policies and advice based upon your own particular circumstances. Sample loans are for illustration purposes only and are not a rate quote, pre-approval, or commitment to lend.

Scott Halliwell and JJ Montanaro are CERTIFIED FINANCIAL PLANNER™ practitioners with USAA Financial Planning Services, one of the USAA family of companies. Certified Financial Planner Board of Standards, Inc. owns the certification marks CFP® and Certified Financial Planner™ in the United States, which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.

USAA Financial Planning Services® refers financial planning services and financial advice provided by USAA Financial Planning Services Insurance Agency, Inc. USAA Financial Planning Services Insurance Agency, Inc. (known as USAA Financial Insurance Company in California, Lic. #0E36312), a registered investment adviser and insurance agency and its wholly owned subsidiary, USAA Financial Advisors, Inc., a registered broker dealer. (known as USAA Financial Insurance Agency in California), a registered investment adviser and insurance agency and its wholly owned subsidiary, USAA Financial Advisors, Inc., a registered broker dealer.

USAA means United Services Automobile Association and its affiliates. Investments provided by USAA Investment Management Company and USAA Financial Advisors Inc., both registered broker dealers. Banking products provided by USAA Federal Savings Bank. Credit cards provided by USAA Savings Bank. Both Banks Member FDIC.