Should I Withdraw from My Roth IRA to Pay Off Debt?

Golden Egg by Mykl Roventine on FlickrAmber writes in with the following question regarding Roth IRA withdrawals:

“I currently owe about $10,000 in credit card debt and have nearly that amount in a Roth IRA I started a few years ago. I share your passion for being debt free and have considered withdrawing the money from my IRA account to pay off my debt. I figure once I’m debt free I can resume Roth IRA contributions and rebuild my account. Your thoughts on this strategy?”

Thanks for writing Amber. I appreciate your desire to become debt free – there is no feeling like it! However, withdrawing money from your Roth IRA to pay down debt could potentially be a bad move. Let’s discuss why.

Four Reasons Not to Tap Your Roth IRA to Pay Down Debts

You might have to pay a penalty if you withdraw from a Roth IRA. Although you can withdraw your contributions to a Roth IRA at any time and for any reason, you will be penalized if you withdraw earnings on your Roth IRA contributions unless the distribution of earnings is qualified.

A distribution is only qualified if you withdraw on or after the date you reach the age of 59 ½; if the withdrawal is made because you become disabled according to the IRS; if the withdrawal is used toward the purchase of a first home; or if the withdrawal left to your beneficiary in your will. The withdrawal of earnings must also be made five tax years or more after your first contribution.

Clearly, most withdrawals of earnings to pay off debt are not qualified. A distribution that is not qualified will be subject to a ten percent additional tax penalty, and you must pay ordinary income taxes on the amount you withdraw. There are no taxes owed on qualified distributions from a Roth IRA.

You diminish the power of compounding interest if you withdraw from a Roth IRA. Even if your distribution is qualified, you will have a smaller balance after you withdraw. This makes for a lower amount of money that can be earning interest, diminishing your returns over time. Once you withdraw contributions from previous tax years, they cannot be reinvested. That opportunity to contribute for that period is gone, forever.

You might be unprepared for retirement if you withdraw from a Roth IRA. A Roth IRA is designed to help you pay for your living expenses when you can no longer work. Withdrawing money from it today may leave you with less money decades from now, increasing the odds of an impoverished retirement.

You may start a bad financial pattern if you withdraw from a Roth IRA. It will likely be easier to withdraw from your Roth IRA again in the future when you need some quick cash after you take your first early distribution. Withdrawing once may start a bad pattern that will keep you from hitting your retirement goals if you make a habit of tapping retirement contributions to pay for your current lifestyle.

All things being equal, it seems best to avoid withdrawing from a Roth IRA to pay off your credit cards and other consumer debts. If you have no other recourse, and your debt is inhibiting your ability to live today and plan for the future, then you might want to take a withdrawal.

If you decide to go this route, I strongly suggest you only remove contributions from your Roth IRA, not the earnings. Allow the earnings to continue to grow, and avoid paying taxes and penalties for withdrawing them early for a non-qualifying event.

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