43-year-old woman calls Suze Orman asking if she can pull from her 401(k) that has $100k in it to pay off loans – hear what she says

A lot of people get into trouble with debt for a variety of reasons. Sometimes, it’s a matter of bad luck, like a string of home or car repairs. Other times, it’s due to losing a paycheck for a period of time.

But either way, debt is bad news. It can cost you a lot of money in interest and wreak havoc on your mental health. So it’s natural to want to get out of debt as quickly as possible.

That’s what prompted a 43-year-old woman to ask financial guru Suze Orman for advice. The woman owes $50,000 in debt but thankfully has over $100,000 in her 401(k). She wants to get out of debt and change her lifestyle, and she’s considering taking a withdrawal from her 401(k) to pay off her debt and start fresh.

Orman, however, had some choice words to say about her idea.

A potentially horrendous mistake

It’s easy to see where this caller was coming from. She has debt and she has savings. Logic might dictate that it makes sense to tap her savings to get rid of her debt rather than let it linger on.

But Orman’s response to that idea was “don’t you dare do that.” And I don’t blame her for having that reaction.

There are numerous problems with taking an early withdrawal from a 401(k) to pay off a debt. First, the caller here is 43 years old, which means she’s not eligible for penalty-free 401(k) withdrawals.

If she takes money out to pay her debt, she’ll lose 10% off the bat. She’ll also face taxes on her withdrawal.

What that means is that even though she only needs $50,000 to cover her debt, she’s going to have to withdraw a lot more than that to account for the penalty as well as the amount the IRS will take from her. So all told, she’s looking at seriously whittling down her 401(k) balance.

But that’s not the only concern. Another issue is that if she takes out that money, she’ll potentially lose out on years of gains. And also, she’ll be out the principal sum she removes. That could put her in a seriously bad spot come retirement.

While it’s true that this woman is only 43 and may have another 20 or more years ahead of her to work and save, she’d effectively be starting almost from scratch by raiding her 401(k) right now. So it makes sense that Orman would discourage a 401(k) withdrawal.

A better approach

It’s rarely a good idea to use a 401(k) plan for anything other than covering living costs in retirement. So in this case, a better bet for the caller is to work with a financial advisor to get her debt under control.

An advisor can help her map out a spending plan that allows her to cut back on bills and free up more money to apply to her debt. An advisor might also have suggestions for consolidating her debt in a manner that makes it more affordable. For example, moving credit card balances into a personal loan could be a more cost-effective means of tackling the debt she has.

One thing the caller has going for her is a decent salary. With a six-figure income, she’s in a position to chip away at her debt steadily with the right financial plan. And that way, she can leave her long-term savings alone and not run the risk of ending up with a massive shortfall once her career comes to an end.