I know what you are asking: “How can there be any cons related to paying down debt?”
If you are not careful, there are several ways you can dig yourself deeper into debt trying to pay loans and other bills.
In a previous blog I addressed the option of cashing in retirement accounts and other investments to pay down debt. While there are a number of benefits to doing this, there are also quite a few downsides as well. In fact, the Department of Labor went public recently warning Americans that making permanent withdrawals from their retirement accounts is not a wise financial move given some of the hefty tax penalties involved. According to Uncle Sam, you could be looking at a 10 to 39 percent tax penalty, plus another 10 percent penalty if you make a permanent withdrawal before age 59. In addition, you are responsible for paying state taxes on the withdrawal as well.
Other drawbacks of withdrawing from your retirement account include getting taxed twice. Still, the double tax may end up costing you less than the interest associated with credit card interest which may be as high as 30 percent. Ultimately, you have to crunch the numbers and see what works best for your individual situation.
However, if you decide to borrow money from your retirement account, consider that failure to repay the loan on time or in full may result in severe penalties. Things can get even trickier if you spent all the money you borrowed and don’t have any cash left to pay taxes. Bottom line: If you do not think you can pay back the loan on time, you should figure out another solution to your debt problem. In addition, if there is a chance you may quit or be terminated from your job where your retirement account is held, you should not take out the loan. Quitting or being fired from a job automatically places the loan balance in the “unpaid” category, and you will be subject to penalties and taxes.