Being in debt is never easy. With bills mounting, selling off an investment might seem like an obvious solution — but in doing so, you may be making a huge mistake, experts say.
Since September 2014, 30 million Americans have tapped retirement savings to pay for an unexpected expense. And in 2011 alone, the Internal Revenue Service collected $5.7 billion in penalties from early withdrawals of retirement accounts. Those same penalties could greatly reduce what you’re expecting to use toward your debt and cost you years trying to recover what you’ve lost.
If you are in debt and feel the walls closing in, take a deep breath and consider these tips from experts.
Don’t panic. Thomas Nitzsche of St. Louis was laid off from his job of seven years when he was barely making ends meet. Strapped with a mortgage, student loans, credit card debt and a car payment, he started to panic. “You’re just thinking, I’ve got these bills and no foreseeable income,” he says.
His skills weren’t easily marketable, and similar jobs were paying $20,000 less than the union job he’d had. Fearing his credit would plummet, he decided to cash in his 401(k) of $20,000 to pay his bills while he was out of work for six weeks. His haste cost him thousands of dollars.
Save your 401(k) as a last resort. Penalty fees and taxes took a huge bite out of Nitzsche’s 401(k) disbursement, cutting it from $20,000 to $12,000. It took him four years to recover his lost savings. “In hindsight, I wish I’d waited or found some other means to pay my bills. I took a hit on the taxes and the fees and had to start all over again at the new job.”
Nitzsche, now 36, went on to become a financial counselor and spokesman at ClearPoint Credit Counseling Solutions based in Atlanta, and saw people in similar situations.
He made the decision to live beneath his means and move back in with his mother. At the time of his job loss, losing his independence seemed devastating, but Nitzsche says the move was actually a good one. He converted his house into a rental that more than paid for his mortgage, and he paid off his student loans, credit cards and saved $60,000 in his 403(b). He also finds money to travel. “I should’ve rolled the 401(k) over and gone back to waiting tables and working three different jobs,” he says.
Work with your lender first. Before selling or walking away from your house, work with your lender to find the most favorable resolution.
“You can work with your lender to do a short sale or some other modification, principal reduction or exit the house without a foreclosure,” says Nitzsche, who now realizes that he could have sold his house he bought with 100 percent financing rather than cashing in his 401(k). “Because it’s been upside down for so long now, and it’s such a stress keeping up on maintenance and tenants. There was no equity whatsoever,” he says.
Try to renegotiate your debt. Creditors are unique and change their policies, says debt resolution attorney Leslie Tayne in Melville, New York, who makes a point of staying abreast of their changes. “When I call them, I have a relationship with them, and they know if I make an agreement with them, I’m going to pay it. We both want our accounts resolved.”
As a result, she says she has been able to transform $100,000 debts into $20,000 interest-free accounts over the course of three or four years.
Know the penalties before selling investments. Make sure you know what you’re risking, like IRS penalties or capital gains taxes from cashing out stocks or other investments. “When they’re in debt, people start selling off everything, from their children’s investments to their jewelry and stocks, without asking questions,” Tayne says.
“Before you make the sale, before you cash it in, you need to talk to your accountant or your financial go-to person who understands your financial situation,” she says. “At the very least, get a consultation with someone who can explain the tax implications of what you’re about to do.”
It may make sense to sell at a certain time of the year to offset a loss in business, for example.
Look at refinance solutions realistically: If debt is simply transferred and you don’t have good budgeting plan, you may end up in the same situation. “Not to mention, using these methods lowers the client’s net worth,” Tayne says.
Don’t spend an entire windfall on your debt. Tayne recently worked with a person who received a large cash award for a disability. It was one lifelong allocation because he could never work again. “He was going to take all the money that he needed to live on and pay off his creditors,” says Tayne, who advised him to instead take a portion of the money and invest it to last longer.
“Budgeting is the No. 1 way to resolve debt without using your investments,” she says.
Create an emergency fund. After college, Daniel Goodwin developed a lucrative real estate career and was enjoying an expensive lifestyle in Austin, Texas, when a sudden energy bubble swallowed most of his income. His bills from his lifestyle were substantial.
“I went into debt, and it left me with the indelible impression that I don’t ever want to be there again,” says Goodwin, now an author and president of Provident Wealth Advisors in The Woodlands, Texas.
He sold his house, car and boat, stopped spending money, and took in roommates. “Make cashing in your 401(k) a move of last resort. First get rid of all the stuff you don’t have to have,” he says.
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7 Fatal Mistakes Investors Must Avoid When Digging Out of Debt originally appeared on usnews.com
