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May 18 2009 12:00AM

Question

I am 61 years old and have approximately $350,000 in my 401(k) and 403(b) retirement plans. I have $50,000 in debt that includes a mortgage (a 30-year with 27 years remaining), credit cards, line of credit, and home improvement loans from my 403(b) plan which total around $50,000. I am losing the battle to keep current with my monthly expenses of which my savings are now depleted and I will soon fail to be current on the payments. Should I withdraw from my 401(k) plan to pay off the non-mortgage debts?

Answer

As with many financial planning questions, Eric Reid, CFP® of Reed Davis Investment Group said answers will vary from planner to planner but generally fall into two camps.

The first camp suggests that you save nine to 12 months of expenses in cash. In addition, you need to control your debt, and invest all available assets into investments that will generate higher returns than the finance charges so that you come out ahead. For example, if your investments make 8 percent, but you pay finance charges of 5 percent, then you get a 3 percent gain.

The second camp would have you save nine to 12 months of expenses in cash, pay off all outstanding debt, including the mortgage, and then invest the remainder for future goals — usually retirement.

"I have found that my clients that fall into the second camp and pay off all outstanding debt are much happier than those that try to profit from the system of low interest rates with high investment returns," said Reid. 

"If your total debt, including your mortgage, is $50,000 and you have $350,000 in qualified plans I would advise you to pay off all of the debt from your 401(k) and 403(b) plans," said Reid. "But only withdraw enough to pay off the debt, allow for tax consequences due to the withdrawal, and give you a cash savings cushion of nine to 12 months of remaining expenses so you can avoid this in the future. The recommendation is assuming that you are employed or will be again, you will have sufficient income to pay your other expenses, and you can make a withdrawal from the plans."

Lastly, Reid said, "it's very important to create a budget that you can follow and to control your spending.  You can create a horrible situation by taking savings and investments to pay off credit cards, loans, automobiles, etc. then spend your way back into a high debt situation."

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