Q. I work for a small company and a new owner is keeping all of us on but he is not going to continue the 401(k) plan. I'm 28, single, and don't have a lot of money in the existing plan but want to do the best with what I have. I have about $12,000 in the plan and I have about the same amount of debt on a credit card with an interest rate of 10 percent. When I was in college, I was told by a financial advisor that I needed to get a credit card. She said this would enable me to establish a credit history and would be helpful when I wanted to buy a car or home. She waived the application fee and I got a credit card! I always pay more than the required minimum and have never made a late payment. I pay $250/month on my credit card and contribute the same monthly amount to my 401(k) plan.
Currently, I'm in the 15 percent tax bracket and a friend/co-worker of mine is suggesting that I take the $12,000 from the plan when it is terminated and pay off my credit card debt. He says that since my interest rate and tax bracket are about the same I should pay the debt off and that I will have plenty of time to save for retirement since I'm so young. My parents are encouraging me to keep the money in some sort of retirement plan since they regret not having saved enough money themselves to live comfortably in retirement. I'm not sure about all of my options and definitely don't know what would be best for me. Any help you can provide would be appreciated.
A. You should be proud of your retirement savings; not so much about your credit card debt but maybe it is the result of some emergency issues and not just "things" you couldn't afford. I'm betting that the college "financial advisor" worked for the credit card company. I agree that it is good to establish credit but you can do so without going into debt. One of your primary financial goals should be to pay off the credit card and once that is accomplished only buy and charge what you can pay off in full each month.
I don't think you should cash in your 401(k) to pay off your credit card debt. Once the plan is terminated, roll the money into an IRA. Do some research or hire a fee-only adviser to help you select a good moderately aggressive no-load mutual fund with which to establish your IRA. You should do what is called a direct transfer from your 401(k) plan to the mutual fund. The customer service representatives where your 401(k) is held and those at the selected mutual fund family will be able to assist you in completing the necessary paperwork for the transfer. If you don't roll the money into an IRA, you will owe Federal and State taxes in addition to a 10 percent early withdrawal penalty. Assuming you are in the 15 percent Federal tax bracket and 5 percent State tax bracket; your $12,000 will be reduced by $3,600 leaving you with $8,400 after taxes and penalties.
I suggest you stop contributing to your 401(k) plan and apply that monthly amount to your credit card debt. At the 15 percent federal and 5 percent state tax bracket your $250/month contribution is equal to $200 in after tax dollars. Adding this amount to the $250 you are currently paying toward your debt will allow you to pay off your credit card in 31 months. Once that is paid off, begin contributing the $450 to a retirement plan. If your employer doesn't offer a plan, contribute to a tax-deductible IRA or a Roth IRA. In 2015, you can contribute up to $5,500 to an IRA ($6,500 if age 50 or over).
Holly Nicholson is a certified financial planner in Raleigh. She cannot answer every question. Reach her at askholly.com or P.O. Box 97128, Raleigh, NC 27624