Hello, this is Noel Dalmacio, your ultimate CPA at lowermytaxnow.
Here’s a tax question, I got from one of my clients:
Should I use my retirement monies to pay off debt?
Here are the facts of the case:
Client has two credit card debts. One credit card has a balance of $40,000 at 20% and another one has a balance of $10,000 at 9%. He wants to pay off both credit cards by taking out some retirement monies? He just wants peace of mind that those credit cards have been taken care of. So what do we do?
The first thing you need to do is to determine your total tax rate. You need to find out both your income tax and the withdrawal penalty rate. The sum is the total tax rate that you need to apply to the retirement amount you want to take out. So for example, your total tax rate is 40% (30% income tax rate and 10% withdrawal penalty rate) and you want to take out $50,000 to pay off your debt, you will be paying $20,000 in taxes ($50K x 40%)! Ouch!
In order to avoid paying taxes, here are the LowerMyTaxNow strategies:
1. You can take out a home equity line of credit. The interest in the first $100,000 is tax deductible. You just exchanged a non-deductible interest to a deductible amount to give you additional tax savings.
2. You can max your 401-K to the extent of the employer’s matching. The rest can be applied toward paying down your credit card debts.
3. You can borrow money from your 401-K. That way, you will avoid the $5,000 of withdrawal penalty.
4. You can negotiate your interest rate with your credit card company with a better rate if you have a good credit.
5. Transfer balances to a lower interest credit cards.
To summarize, make sure that you look at alternative options before taking out retirement monies to pay off debts. That way, you can avoid paying huge amount of taxes and maximize the use of your monies.
If you like to learn more, click the link lowermytaxnow.com and sign-in to receive my weekly blog.
Until then, this is Noel Dalmacio, your ultimate CPA at lowermytaxnow.com.