Should You Use Your 401K to Pay Off Debt? 

Key Takeaways 

• Withdrawing funds from your 401(k) could help you pay off high-interest debt holding you back financially. 
• However, 401(k) withdrawals can carry tax implications as well as penalty fees, and you’ll lose out on potential growth when you take money out of the market. 
• You could consider a 401(k) loan, but you’ll have to repay the funds within five years. 
• Other options include budgeting, negotiating, debt consolidation loans, and using your home equity. 

It can be hard to carry debt knowing you have thousands of dollars in your 401(k) account. You might feel like that money could be better spent now instead of some far-off day in the future. However, using your 401(k) to pay off debt can have some pretty important consequences.  

Let’s talk about the pros and cons of using your 401(k) to pay off debt and examine some alternatives that might be a better option for your situation. 

The Appeal of Using 401(k) Funds

If you’ve been working full-time for a while, you’ve probably built up funds in your retirement account. In fact, the average 401(k) balance for a 40-year-old is more than $100,000, according to 2024 data from Fidelity.  

For those struggling with credit card debt, access to such a sum can be tempting. After all, withdrawing some of that cash could help by: 

• Providing immediate relief from debt 
• Cutting down on the interest you owe 
• Simplifying your finances 

But it can have downsides, too. 

The Hidden Costs and Risks 

A 401(k) is a retirement plan — not a savings account. Still, some plans may allow a hardship withdrawal, meaning you can take money out of the account for use before you retire. Using that money to pay off debt comes with costs, including: 

• Penalties for early withdrawal, which are usually 10% of the withdrawal amount 
• Tax implications, especially if you are younger than 59 ½  
• Lost investment growth  
• Possibly delayed retirement 

Taking money out of a 401(k) means losing out on possible gains until the money is replaced. Every dollar that you remove is a dollar that won’t be earning investment income or helping to grow your portfolio. When you factor in penalties and taxes, it becomes even more expensive. 

When it May Make Sense

However, as costly as it can be to make an early withdrawal from your 401(k), there are times when it might make sense.  

You’re deeply in debt 

When you are drowning in high-interest debt, it can require a serious infusion of cash toward your balance if you want to make progress. Otherwise — especially with credit cards, which have an average interest rate of 21% these days – it’s easy to fall further behind. 

You’re facing bankruptcy 

Another reason you may want to tap your 401(k) account is if you’re facing bankruptcy, legal actions, or foreclosure due to your debts. Using retirement funds may help you preserve important assets like your car or house. It also means you can begin to pay off debt and rebuild your credit if it’s taken a hit. Bankruptcy can stay on your credit report for up to 10 years, making it tougher to buy a car or home in the future.  Alternative Solutions to Consider 

Alternative Solutions to Consider 

Before you commit to taking money from your 401(k), consider whether there may be alternatives that could work better for you. 

Debt management plan 

If you’re struggling with credit card debt, a debt management plan might help. A debt management plan is crafted by a credit counseling company. It typically lowers your rate and extends your repayment period. That usually gives you a lower payment, making it easier to pay off your debt. Debt management plans are for unsecured debts only, like personal loans or credit cards, so they’re not an option for debts secured by collateral (such as a mortgage). 

401(k) loan 

There is a difference between making a big withdrawal from your 401(k) and taking out a loan against it. A 401(k) loan means you take out the money, but it’s not permanent; you’ll be paying it back with interest. Both the amount you borrow and the interest goes back into your account.  

There is a limit on how much you can borrow from your 401(k): usually $50,000 or 50% of your vested account balance, whichever is less. You’ll only have 5 years to pay back the loan, or less if you leave your job. 

Negotiating 

It’s worth contacting your creditors to see whether they’ll work with you to negotiate your debts. If you’re experiencing a financial hardship, such as loss of employment, explain the situation and see whether you can agree on a new payment plan. Keep in mind this could extend your timeline for repaying the debt, which could cost you extra in interest. 

Debt settlement services 

If you don’t want to (or don’t have time to) negotiate with your creditors directly, a debt settlement service could help. Debt settlement companies take over those negotiations on your behalf, with the goal of reducing what you owe. There is usually a fee for this service, but the time and effort it saves you could be worth it. 

Debt consolidation loan 

A debt consolidation loan is a type of loan you can use to pay off multiple creditors, leaving you with just one payment. The lender may even pay your creditors directly on your behalf. Debt consolidation loans could have a lower interest rate, and there are usually flat, fixed payments. Just make sure you’re not creating more problems for yourself by taking on additional debt. 

Home equity solutions 

You can use the equity in your home for cash through one of the methods below. 

Home equity loan: A home equity loan is considered a type of second mortgage, and can be used to access a lump sum of cash that you can use to pay off your other debts. Home equity loans usually have lower interest rates than credit cards and personal loans because they use your home equity as collateral. 

HELOC: A HELOC is a home equity line of credit that you can draw from as needed during the draw phase, then repay later during the repayment period. HELOCs also use your home equity to secure the loan, and tend to have variable interest rates, meaning the rate can change periodically. 

HEA: A home equity agreement, or HEA, is a different way to use your home equity to pay off debt. Because it’s not a loan, you won’t be taking on additional debt, accruing interest, or making monthly payments, and you don’t need perfect credit to qualify. Instead, you receive a sum of cash up front in exchange for a portion of your home’s future value. Unlock offers home equity agreements with a two-minute pre-qualification, so you can see how much you could qualify for before deciding. 

Paying off debt isn’t easy, and it’s wise to explore all of your options. Before you choose a payoff solution, find out the total cost of each option, including interest, penalties, fees and taxes. In the case of using your 401(k) funds, talk to a financial professional to learn the implications of this decision so you’re prepared to handle the outcome and its effect on your retirement plans.