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Paying Off Debt with Roth IRA Funds

Keep the money in my Roth IRA or use it to pay off my credit card debt?

i have about 25,000/30,000 in credit cared debt,from college for my kid's and being out of work at various time's and finally out of work for good at age 55 from being hurt on the job permentaly with a internal body problem. i can payoff this debt if i want too, but i'm keeping my money intact to generate money in my Roth. my question is should i payoff the debt and start rebulding back my Roth back, i only pay 1% or less on my credit card bills and i do pay more then the minimum anyways. thank's for answer

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Bill's Answer
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Updated: Sep 23, 2014

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Highlights

  • Check to see if you are eligible for a penalty-free withdrawal from your Roth IRA.
  • Avoid using retirement funds to pay low interest debt, if you can afford the monthly payment.
  • Consult with a tax professional before taking any action that can result in taxes and penalties

Thank you for your question about your credit card debt, your Roth IRA, and the best way to pay off your debt. There are some facts missing from your question that I need to fully address the issues you raised.  Therefore, I will make some general comments and observations.

Avoiding Penalties for Roth Withdrawal

You did not state whether your retirement account was always a Roth IRA or if you converted a traditional IRA or other retirement account into a Roth IRA. Taxes are not due on this kind of withdrawal, but if you did a Roth conversion, then your withdrawal could be subject to 10% penalty if your withdrawal happens before five years have passed from the conversion date. Roth conversion or not, you could be exempt from the penalty, if you meet one of the penalty exceptions listed below.

You also did not state how old you are currently, but you appear to be able to withdraw money from your Roth IRA account without penalty. I say appear, because one of the rules that allow for penalty-free withdrawals is if you are disabled. It is important to check and see if you meet the IRS rules for disability.

Penalty exceptions include:

  • You are age 59½ or older
  • You are disabled.
  • The IRA disbursement was made to a beneficiary of your estate, after your death.
  • The distribution is used to for a first-time homebuyer purchase, under certain restrictions.
  • Your medical expenses are greater than 7.5% of your yearly adjusted gross income, accounting for any reimbursements you received
  • The IRS levied your IRA
  • You are paying COBRA or other medical insurance premiums after a job loss
  • The distributions are not greater than your qualified higher education expenses.

Assuming that you can take money out of your Roth IRA without penalty, the question remains whether it is wise to do so. The purpose of the withdrawal certainly plays a big part in the decision.

Paying Off Low-Interest Debt

In your case, you wonder if it is wise to take out funds from your Roth IRA to pay off low interest credit cards. It is rare to have $25,000-$30,000 in credit card debt at less than 1% interest. Are these interest rates good for the life of the debt or are they part of a low-interest balance transfer? If the initial ‘teaser rate’ is set to expire and your rates will rise, that gives you greater incentive to pay off the debt. Another factor that would make it wise to pay off the debt would be if you were at all concerned that you could not meet your minimum payment obligations, in which case the interest rate could be hiked to 29.99% or greater. Because you said that you are able to pay more than your minimum, this factor appears to be a non-issue.

The 1% interest rate is so low, it would seem that your investments, even at time when returns on safe investments are low, are likely generatin greater than a 1% return. Because the Roth IRA disbursements are tax-free, due to the fact that you paid taxes on the money you used to deposit in the account, they are ideal for long term planning. It is not just the funds you deposited in the account, but the gain in any of your investments in the Roth that are tax-free at withdrawal. Roth IRA funds are not subject to age based withdrawal requirements, as opposed to traditional IRAs that require certain withdrawals beginning at age 70. This gives you the benefit of keeping all your funds in the Roth, as you see fit,  and not paying taxes on any of the gains your investments earn.

Ability to Pay

I am guessing that your minimum payment on your credit cards is around $750-$900 per month or $9,000-$10,800 per year. At 1% interest, you are adding only $250-$300 in interest per year, which will decrease as you pay down your principal balances. This means you are looking at less than a three year payoff of all your debt or even less, as you said you are paying more than your minimums.

Recommendation

If you can afford to maintain the level of payment you are currently making, then that is the best choice, in my view. Given the low interest rate and the fact that you are not under financial stress, taking money from your Roth seems to be a poor idea. If you ever need money for an emergency it is best to have the money in the Roth and allow the funds to grow, tax-free, for the time being.

Rules can change from year to year regarding retirement accounts or any tax issue. For a full discussion of IRS rules on retirement accounts, please visit the IRS Web site  section on retirement accounts. I recommend discussing any complicated tax questions with a tax professional, before you take any action that could result in taxes or tax penalties.