Reader Advice: Pia 401K or Debt?

Free Money Finance has a fabulous help a reader section where he posts questions that his readers has asked him and allows his reading audience to weight in. When Pia left a detailed comment on a post and wanted some advice on what to do with her financial situation, I thought, why not open it up to everyone since lots of people have money problems? Pia agreed, and below is her story. Be nice and civil everyone. Remember, this is a real person with a real problem in real life.

I’m 28 yrs old, and have been with the same employer for the last 7 years. I donate 5% per paycheck to my 401k the last 4 years or so and 2% before that. My company’s maximum match up I believe is 4%. And unfortunately, that’s as far as my knowledge about 401k goes. [According to the 401K site] I have $4,357 for Cons. Ret. Benefit Plan (which I have no idea what it is) and $13,638.21 for 401k RSA Plan. This gives me a total market value of $17,995.22.

I have 4 credit cards, and 3 of them I have stopped paying since the last year or so. I also have a car loan. Last month I received a letter from Chase’s Legal Dept, informing me that they filed a lawsuit against me for the money I owe, which was around $4,200. This scared me and made me really think about the consequence of not paying my debts. I didn’t worry too much about the collection calls and letters I’ve been getting in the past. But a lawsuit is a whole different story. I called them to make payment arrangements. They said along with the $4,200 balance, I also owe them $800 for late fees. They offered me $2,800 to settle which I agreed to. In fact, I just cut the check yesterday, which will now leave me in a very, very tight budget.

These are rough estimates of balances for the remaining credit cards that I have stopped paying (which I am hoping to settle once I get funds):
Discover – $2,800, Another Chase CC – $4,000, Chase/Wamu – $500 (This was a bank account). And I am paying these currently, since they are from the same establishment: Credit card – $2,700 (I am making the min. payment of $54 and $33 goes to the interest, WTF?); Car loan – $3,900 (6% interest) ($333 a month). My net income for two weeks is around $825. As far as monthly expenses go, aside from the two above, I have [expenses totalling $650 including utilities, car and motorcycle insurance, gas, phone & internet,] plus food and necessities.

I really, really want to take care of my debts, and build my credit back up again. I definitely learned my lesson and would love to have a fresh start. Do you think taking a 401k loan is a good idea for me? How much is it really going to cost me? What other options do I have? Any advice from you and your readers will be greatly appreciated!!

What advice do YOU have for Pia?

Join the newsletter

Subscribe to get our latest content by email.

We won't send you spam. Unsubscribe at any time. Powered by ConvertKit
Related Posts Plugin for WordPress, Blogger...

27 thoughts on “Reader Advice: Pia 401K or Debt?

  • How did you get into such a bad situation in the first place? You can’t just go around spending money and assume that there will be no consequences.

    Now that you are there, you have to figure out how to pay off your debts without touching your 401(k). If you are on a tight budget, make it tighter. Stop eating out, stop buying new clothes, stop going on vacations. Make major lifestyle changes.

    Why do you have a car and a motorcycle? Sell one of them. Save on the insurance and use the cash to pay off debt. That should be obvious.

    Your credit is already probably shot (you can use CreditKarma.com to check for free), so that is not a huge concern, but you should try to fix this ASAP so you can get on with your life.

    I suggest reading into the debt snowball (http://www.narrowbridge.net/2009/06/my-debt-how-im-paying-it-and-the-snowball-effect/ or http://www.daveramsey.com/article/get-out-of-debt-with-the-debt-snowball-plan/).

    This might sound a little harsh, but it looks like you need to take this a bit more seriously. Good job on the retirement savings. Don’t stop the part you are doing right. Just make some lifestyle changes and get this under control.

  • I think you have to pay back the 401(k) loan, but I’m not sure how much they would require a month. That could work though, since you seem to have enough to pay everything off in one fell swoop. The real issue is that you’ll lose the growth on the account in the meantime. You can probably call the company that provides the plan to see how that would effect the account and how much they would require you to pay back.

    Is it possible to do a balance transfer onto one card and pay it off before the low rate expires? Discover had a good one a couple of years ago, about 3% or so and my husband had 3 years at that rate to pay it off. The bonus was, the total minimums he had been paying to about 5 different cards was making a huge dent in the amount owed.

    Could you look at getting a part-time job or parlaying a strength into a side job? Or maybe you can call the credit card companies and see if they can settle or lower your rate? I’m not entirely sure what your best course of action would be, but there are several things you could check into.

  • You had me at “loan”.

    Taking out money to invest in your 401k (I’m assuming) is not something I’d do. If I don’t have the money, I don’t invest it.

    Or if you’re talking about taking out money from the 401k to live, then it’s just another type of credit, seeing as you have to pay it back….

  • If I were in your situation, I would only contribute the minimum to get the maximum company match in your 401(k), so 4%. I’d also either sell the motorcycle or car to cut expenses to the bare bones (probably the car since it has a loan).

    While working on that, call each of the companies and ask how little they would be willing to take to settle out the accounts (just like you ended up doing with Chase). Use the money from the motorcycle or car to pay off each one and if you have any debt left, start shoveling all your extra money towards it each month.

    It looks like you have less than $7500 of debt so selling the car or motorcycle could take care of AT LEAST half and then you can pay off the remaining $3500 with the extra money every month.

    Based on the numbers you mentioned, that means you could pay off all your debt by the end of the year.

    I wouldn’t touch what is in your 401(k).

    • I like this answer the best. Touching your 401k should be the last resort to lifestyle changes and selling your car. It’s the opportunity costs that will get you int he end with you touching your 401k.

  • Hi Pia,

    If you plan to borrow from your 401(k) retirement plan, please be careful. Plan loans usually charge the prime interest rate plus one or two percentage points. Because the interest you pay goes right back into your 401(k) account, you might think of this as a “free” loan. Not so. In fact, it could cost you more than the stated rate because you could be losing out on earnings. And you lose future compounding on the lost earnings. In time, that could amount to quite a nest egg.

    Another potential problem is that if you quit or lose your job, your loan may be due immediately. This could be at a time you may least be able to afford to pay back the loan. If you can’t pay back the loan, the loan would be considered a distribution. That means you would owe taxes on this distribution and, since you are under age 55, you would get hit with an early withdrawal penalty too.

    If you are unable to come up with a solution on your own or have difficulty working out payment arrangements with all of your creditors, you might want to consider talking with a trained counselor about your options. I’ve worked for the nonprofit Money Management International for 16 years. A counseling session with MMI is free and confidential.

    One final thought: If you are able to negotiate repayment plans on your own, be sure to get the details in writing to prevent future problems.

    Good luck!

  • As others suggested, I’d sell the motorcycle or the car. You may enjoy and want a motorcycle and feel you ‘need’ it but you don’t have enough money to afford 2 vehicles. Gas savings for a motorcycle are not enough to justify the extra cost either. Pick one vehicle to keep and get rid of the other one. Most places the car would be better as its usable year round.

    You have some debts that you are not paying on for “the last year or so”. For those debts I’d just let them be and not pay them off until you have some money that you can offer to settle with the banks in question.

    Otherwise using a debt snowball would be the best way for you to dig yourself out of debt.

    Regarding the 401k loan. A 401k loan is an actual loan that you may payments on. Its different and better than simply raiding your retirement. The exact terms of a 401k loan will depend on your 401k plan. My plan has loans at 4.25% and fees of around $100. Yours may differ with different interest rate and fees. Generally you can borrow up to 50% of your 401k balance from yourself. You of course have to make payments to pay back that money. One problem is that borrowing from yourself will keep your 401k retirement from growing well. Paying yourself 4.25% interest is not very good growth. Also if you end employment with that company then its most likely that they’ll demand immediate repayment of the loan at that time. So if you get laid off, fired or quit then you’ll likely be responsible for repaying the money. If you don’t have the money to pay them back they’ll empty your 401k to get it and you’ll have to pay taxes and penalties. 401k loans should usually be avoided for this reason.

  • I think she needs to stop contributing to her retirement plan and use that money to start paying her debts. She can stop the lawsuits and settle these debts out of court by writing letters to her creditors. She wouldn’t need a loan if she uses the contribution money to pay down her debts. I would never advise a client to use a 401k loan to pay off credit card bills.

  • Lots of good advice in here so far. I’ll just add a few things:

    1. You’ve got to sell the car or the motorcycle, keeping both just doesn’t make sense. Additionally, look around and try to find other stuff to sell. Your income doesn’t support your debts so you’ve got to do something about bringing your income up.

    2. You may want to consider getting a second job. You didn’t mention whether daycare or other considerations would stop you from doing this. If there’s no real impediment, definitely look into getting a second job. Or even a better first job!

    3. After you get a copy of your credit report, determine who you owe and how much you owe each of them. I think you could have settled the Chase lawsuit for less but we’re here now. Determine which banks you owe and start attacking each. If they’ve already charged off, work your way through the ones that haven’t charged off yet based on interest rate and then work through the other ones based on balance, smallest first.

    4. Try to reduce your expenses. You could possibly get a roommate or move in with family, spend some time shopping for better insurance, etc…

    5. With regards to the 401k, I’d keep it up to the amount that your company matches but no more than that. I wouldn’t do a 401k loan if only for the reason that you may end up changing jobs and then be in a mess if you can’t repay it all at once.

    Good luck!

  • Thank you so much for all the feedbacks! I really appreciate it. I did talk to my 401k agent today and Jim, everything you’ve mentioned on your post is what was said about my plan. From the interest rate to how much I can borrow (half of it), and it is not alot. I think I am convinced now, that I shouldn’t take the loan and leave my 401k alone. I will however, like some of you guys suggested, lower my 401k contribution. I would really really really *hate* to part ways with my motorcycle, but I will consider it as my last resort. I have just signed up to myfico for free to check my credit score and as expected it was bad. I saw my credit cards there and a collection agency account EQUABLE for $3,941, which did not match any of my outstanding credit card balances. Should I be worried about this particular account? Should I leave it alone and deal exclusively with the credit card companies?

    In response to the first post, I got into this mess because I was in my early 20’s and did not know any better. Being served with a lawsuit was the wake up call for me. I am learning my lesson now.

    I doubt I can open an account with any lending companies now for loans or balance transfers (Stephanie, I actually have that account with Discover [3%apr for the life of the balance] which I stopped paying unfortunately). I was thinking of asking my gf if she could apply for a loan. She has a good credit score, I’m sure she would get great rates. Is there a particular loan she should apply for? Does Wells Fargo offer loans? Sorry for being too elaborate!

    Thanks again guys, the replies have been very helpful in my decision not to take money from my 401k.!

    ps. Jim I see it too, the article is squished into just one column!

    • DON’T LET YOUR GF APPLY FOR A LOAN!!!

      In addition to ruining your relationship — do you really want your girlfriend as your creditor??? — it’s a bad decision for her. Work your way through this slowly just like suggested in this thread.

      If you’re really serious about digging out of this, sell the motorcycle (and other stuff) and work more.

  • I haven’t read the other comments yet, but my answer is no, I don’t think a 401k loan is a good idea. You can’t borrow your way out of debt — that’s just rearranging it, and putting it into a more precarious position (where you could owe all of the money instantly if you were to lose your job for any reason.)

    The best way to get out of debt is to change your behavior. If it were me I would sell things, work extra, and cut back on expenses.

  • This wake-up call should make you get your act together. Take a hard look at your expenses and your priority is to get out debt as quickly as possible and stay out of debt. This may mean suspending your contributions to your 401K.

  • Dude! Wake up again, you are still half asleep.
    You need to sell off some stuffs and pay off the debt. Do it the simple way. Don’t try to do all the tricky stuff like borrowing from 401k or getting your GF to ruin her credit too. You will just dig yourself another hole.

    You need a lifestyle change. Spend less money or earn more. Get a second/third job if you like spending money that much. $825 every two weeks ain’t gonna cut it.
    Go see Jeff at deliverawaydebt.com

  • Fundamentally speaking, taking on more debt to pay current debt is the worst idea in the history of bad ideas, since Mrs. Lincoln said to President Lincoln “I don’t feel like staying in tonight Dear, why don’t we go out and catch a show?”
    First priority is to pay off that consumer debt by eating PBJs only for the next year, cut expenses to the bone, temporarily stop contributing to the 401k (missing out on “free money” match by your company – dang…) *and* taking on a second job if you can.

    • Yep, add in rice and beans for variety. Check out the blog “Grocery Coupon Guide” and how the guy lived on $1 a day for groceries. http://www.grocerycouponguide.com/articles/eating-well-on-1-a-day/

      Cut living expenses to the bone, find free and cheap ways to acquire life’s necessities, and funnel every penny into your debt repayment, but DON’T get the 401(k) loan or ruin your relationship by involving her in your debt. I also think the debt snowball shared above is a good method for you.

      I also think you need to sell your motorcycle and put that $$ toward debt. When you are debt free, you can put the amount you’ve been paying into your snowball toward another motorcycle, paid for in cash. Tough times call for tough measures, and when you’re back in a financially stable place you’ll have room in your budget for luxuries like an extra vehicle. With so much debt, you just don’t have it.

  • I would strongly advise that you not touch your 401(k) or any other investment that you may have. If you remove them to pay off your debts, you will have no compounding of your hard-earned money, plus you will be more likely to get into debt again!

    I know you said that you have learned your lesson, but honestly, if you learn how much sweat it takes to pay off that debt (will most likely take over a year of an extra part-time job to pay off), you have a better chance of never putting yourself in that position again!

    If you would just pay the debt off with your 401(k), I don’t really believe a lesson is learned. It’s an amount of money that you really don’t feel you’ve worked for (since it’s been on an automatic deduction) and once it’s gone, it will feel no different to you anyway because you were not deeply involved in the investment anyway.

    Do whatever you can to keep your investments where they are and pay off your debts another way.

  • There is a lot of good advice in these comments. In my opinion, (and I’m not a financial adviser by any means – however I was in a similar situation when I was your age) my advise is to work out payment plans with your credit card companies. Explain to them that you really want to pay off your debt, but you need some help in doing that (sometimes companies have “hardship” terms where they lower the APR of the loan).

    I would also consider selling some of your things, have a Craigslist garage sale. You mentioned you really didn’t want to part with your motorcycle. Could you part with your car and use the motorcycle as your main means of transportation? This could free up some money that you could apply towards your credit cards. What about getting a part-time job on the weekends or at night? This could help bring in a little bit more income for you.

    As for repairing your credit, be diligent. As you begin paying off your credit cards, make sure the companies are reporting your payments as on-time (make sure you make your payments from here on out ON-TIME!). In my case, it took me 7 YEARS to repair my credit. However, I really messed it up. You’re catching it before it’s completely a wash (good for you, BTW). If you make your payments on time and stick with a plan, you could repair your credit within 2-3 years as credit bureaus list payment history over a 2 to 3 year span.(I’m quickly summing this up as my response is getting LONG.) Be sure to check out my ebook on increasing your credit score. It goes into more detail on how to rebuild credit.

    Good luck to you and let us know what happens!

  • Thanks again for your reactions, suggestions and advices guys! YOu made some really good points on your posts… I will not touch my 401k, nor will I ask my gf to apply for a loan.. and maybe with this new gameplan I have, I wouldn’t have to force to sell my motorcycle!

    I just asked my boss if I could work 40 hours again per week versus 32hrs. That will give me extra $$. I listed out all my expenses in a month, and with the new income, I should have $1000 left (more or less). I just need to figure out how much I can transfer bi-weekly to my savings to see that figure every month. I am also planning to withdraw $200 at the beginning of the month to use for gas and food for that month. That way I don’t use my atm anymore, as that’s the number one reason I lose track of my spendings. Based on my settlement with Chase, from the original money I owe, I only paid 60% of it. I am hoping I can do this with the two other credit cards. If that should happen, I only need $4,321 to settle! If I stay on track (and my figures are right!), I can pay them off in as soon as 5 months!

    My weakness is the ease of transferring to and fro of your checkings and savings account.. Is there anyway you can “lock” the money in your savings, meaning you can’t transfer it back to your checkings or withdraw it? I just don’t want to be tempted in doing that, as I’ve done in the past. I will check out the helpful links you guys have provided! Thanks again everyone!

    • Pia. The best thing for you to do if you want to make your money untouchable is have a portion of it directly deposited into an account where it’s difficult to immediately access it. I’d suggest doing a direct deposit from your job of a certain percentage of your payroll into something like and ING account. If you don’t have an ING account and want to open one I can send you a link where they will give you $25 for opening the account.

      I hope that you get some more time at your job, but as others suggested, there are some ways to make some more money including a second job. I know that Macy’s is hiring (they hired me but I didn’t have the time) for part-time employees. Jeff, another blogger is delivering pizzas and makes decent money doing it part-time as well. The Saved Quarter, (her response is here) did a 4 part series on how to make an extra $1,000. Click on her name and hop over to her site and check out that series.

      If you are settling with the credit card companies get the settlement letter in writing which dictates how much they will settle for. Then pay them as agreed and keep the proof of payment for a couple of years. Once it has been paid off ask have any collections removed from your credit report with your new proof. If you can make extra money, and pay those bills off then direct those funds to the other accounts that you have. Good luck!

    • Good job, it sounds like your attitude and your mind are on the right track. I’d not worry so much about your savings right now. Keep a small emergency fund of $1000 in your savings — only to be touched for emergencies — pay all of your bills when you get paid (including big payments on your debt) and just live off of the rest until your next paycheck.

      And if you’re only working 32-40 hours, definitely find another job to expand your income.

  • I only skimmed through the answers, but, creditors can’t touch your 401(k).
    So leave it alone.
    I hope your girlfriend is smart enough to RUN if you ask her to take on your debt.
    Put on your big girl panties, call up your creditors as someone else said, do a sob song and dance, and see if you can get your APR lowered, or get the settlement (in writing), and if at all possible, take a side job.
    Although your income is small, so are the debts you listed.
    A weekend job will have your debts cleared in no time.

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.