Use my Roth IRA to clean the slate?

Clean slate - shutterstock_53976814Q: Should I redeem my ROTH IRA to pay off large amount of debt? I got laid off over a year ago. I accrued just over $15,000 in credit card debt dur­ing that time (some of that included med­ical bills). Inter­est rate on credit card is almost 17%. I will only make aprx. $38,000/year. Raise in future not likely. I have $250,000 in a tra­di­tional IRA that I won’t touch. I have $18,000 in a ROTH IRA. Am I best off redeem­ing the ROTH to pay off credit card debt and start new year off with a clean slate — and cut­ting up the credit card? Or am I bet­ter off tak­ing a few years to pay off card? I can only pay about $400 towards card each month (and that’s only because I live at home, oth­er­wise would be even less). Many thanks for your response.

–Bren­nan, Tennessee

A: I’m sorry to hear about your lay­off and I hope things are going bet­ter for you.

Not a Sim­ple Deci­sion
As for whether or not you should use your Roth IRA to elim­i­nate your debt, I’m afraid the answer isn’t as straight­for­ward as either of us would like. On one hand, it’s gen­er­ally a bad idea to use retire­ment funds for any­thing other than retire­ment. On the other hand, liv­ing under a crush­ing bur­den of high inter­est rate debt can be prob­lem­atic from a qual­ity of life per­spec­tive and, as you’ve pointed out, it can also be a bad finan­cial move given the money wasted on inter­est expense.

So what do you do?

Usu­ally a Bad Idea
I’ll start by say­ing that for me, using the Roth IRA would be com­pletely off the table if you aren’t com­pletely sure your days of incur­ring con­sumer debt are over. There’s noth­ing to be gained by using retire­ment funds to pay off debt and then run­ning up the debt again. Also, you need to under­stand that even though your reg­u­lar Roth IRA con­tri­bu­tions can be with­drawn at any time with­out taxes or penal­ties, the same can­not be said for earn­ings in the account. If you with­drawal them before age 59 ½ you’re gen­er­ally going to have to pay taxes and a 10% penalty. Finally, elim­i­nat­ing a valu­able finan­cial plan­ning tool like a Roth IRA isn’t some­thing to be taken lightly. You could very well regret giv­ing up the poten­tial for tax-free retire­ment income when the time comes. It’s for all of these rea­sons (and more) that I typ­i­cally tell peo­ple not to do what you’re con­tem­plat­ing. It really is a bad idea most of the time.

Some­times It Can Work
Hav­ing said all of that though, I also have to admit that it’s pos­si­ble your sit­u­a­tion might be dif­fer­ent than most. Even though I wouldn’t rec­om­mend it, I have seen peo­ple play the slate-cleaning game and have things turn out okay. Are you in that group? Unfor­tu­nately, there’s no way for either of us to know in advance. That’s a gam­ble that only you can decide if you should take. If you do decide to take it, just be sure to check with a CPA or other qual­i­fied tax advi­sor first to make sure you fully under­stand the tax implications.

Thank you so much for your ques­tion. I real­ize I didn’t give you a defin­i­tive answer but I hope the thoughts I’ve offered here are help­ful for you in decid­ing what to do and I wish you all the best.

Scott

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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.

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