Year End Tax Tip

Why It Looks Attractive

In a time of stock market volatility, you might have seen your retirement investment returns diminish – and even go negative – it might be tempting to put that money to better use by paying off debt and getting rid of the interest payments. On top of that, there is fact that when you borrow from your retirement plan, you are borrowing from yourself. So, you pay off your credit card debt, but you still need to repay your 401(k) loan. You make payments plus interest back into your account, so you are paying yourself the interest, rather than giving it to the credit card companies.

This seems like a great idea, especially since, if it is a loan from your retirement account, you won’t be charged the 10% penalty (this is on top of your tax rate) for withdrawing before reaching the age of 59-1/2, and you won’t have to report the money as income.

Why You Shouldn’t Do It

Of course, there are downsides to using retirement account money to pay off your credit card debt. First of all, if you withdraw the money outright, without using a loan, you will have to pay a penalty of 10% of the amount, if you aren’t 59-1/2. Plus, the withdrawal amount will be added to your income, and you will have to pay income tax on it.

Even if you go the loan route instead, there are definite downsides to using retirement money to pay off credit card debt. You will have to pay a loan fee and you will have missed opportunities. Without that money sitting in your retirement account, working for you, you won’t have as much later. Yes, you are putting the money back as you repay your loan, but for a time, the capital was missing from your account, and you missed out on compound interest. That will result in a smaller nest egg over time.

You also can’t discount the problems that can come with a retirement account loan if you are laid off. If you lose your job while you have a loan outstanding, most plans require that you repay the remainder of the balance within 60 days. If you default on your 401(k) loan, you won’t see a ding on your credit report, but your loan will be reported as a distribution, and you will then be subject to penalties and taxes.

In many cases, taking money out of your retirement account has the potential to cost a great deal. Consider the viability of putting together a debt reduction plan before you withdraw money from your retirement account. If you do decide to take the money from your account, make sure you repay it as quickly as you can, and try to avoid penalties and taxes.

Cut Back on Travel

One of the biggest summer money drains is travel. Whether it’s just a long weekend road trip or a cross-country adventure, the entire trip can cost an arm and a leg. Airfare is costly, gas is very high compared to last year, and dining out while on the road adds up quick. So this year think about some ideas for fun activities that are local. Use this summer to explore your home state or locations nearby you’ve never thought of.

Watch the Impulse Buys

Summer is often a time for shopping, and that can mean danger for your credit card balance. When you are out shopping you should have an idea of what you want to buy. If you’re just shopping for the sake of getting out of the house you’re setting yourself up for unnecessary purchases that you may regret later.

Go To Yard Sales

Once the weather warms up it’s a sure sign of yard sales to start popping up. The great thing about yard sales is that they don’t even take credit cards. So not only can you satisfy your urge to shop, but you can probably find some inexpensive items and leave the credit card at home.

Start Budgeting

I know, you probably think the word budget is a four-letter word, but it isn’t as bad as it sounds. Nobody likes budgeting, especially in the summer, but it really is the key to getting your finances under control and it will help you avoid overspending on credit cards. Think of it this way. If you have ever tried dieting you probably know that you have to pay attention to what you eat and how many calories, carbs, and fat different foods have. Without knowing what you’re eating you have no way of knowing whether or not you’re making the right choices.

The same is true for a budget and your finances. You need to know how much money you have to spend, what your spending it on, and what effect those choices have on your overall financial health. Without knowing that you’ll always be in the dark. But just like dieting, after you get used to the idea of paying better attention to your actions it becomes habit and you don’t even have to think about all the little details any longer. If you haven’t done it already, create a budget and watch your finances improve.

Start Saving for Christmas

Thinking about Christmas in the summer? No, I’m not crazy. But the holidays are always a time of year that creeps up on us and we can get carried away with all the spending for the holiday parties and gifts. So, rather than set yourself up for a credit card fueled holiday start putting some money away today. Just set aside twenty dollars a week and you’ll easily have about $400 saved up by December. Your credit card will be thankful you thought ahead come winter.

Tax debt? Now that’s a different story. Learn how to get rid of an IRS tax lien.