Why You Shouldn’t Withdraw From Your Retirement to Pay Off Debt

If you’re drowning in a sea of credit card bills, student loans and other debt, you might be tempted to do something desperate to cover your payments—including borrowing from your retirement. But hold up! Raiding your retirement fund is a terrible idea that’ll only dig you into a deeper hole.

Let's take a closer look at why cashing out your retirement is never worth it.

Should I Withdraw From My Retirement to Pay Off Debt?

No, you shouldn’t pull money out of your 401(k) or IRA—even to pay off debt. Not only will you get hit with outrageous early withdrawal penalties and have to pay taxes on anything you take out, but you’re also stealing from your future self!

The only time you should even consider taking money out of your retirement accounts early is to avoid a bankruptcy or foreclosure. Otherwise, hands off the 401(k)!

When you do the math, you’ll see you’re better off leaving your retirement investments alone and finding other ways to get rid of your debt.

What Are the Penalties for Early Retirement Withdrawals?

If you withdraw money from your retirement account before age 59 ½, you'll generally owe a 10% early withdrawal penalty on the taxable portion of your distribution, plus any applicable income taxes.³ In other words, cashing out your retirement is a lot more expensive than most people realize.

Retirement accounts like a 401(k) or an IRA (Individual Retirement Account) are designed to help you build wealth for retirement. That's why the IRS discourages early withdrawals by charging penalties and taxes when you take money out too soon.

Any money you take out of a retirement account before you’re 59 ½ years old must be transferred to another retirement account within 60 days (this is called a nontaxable rollover).⁴ We repeat: 60 days! Otherwise, the money is considered to be cashed out, and the government will take its cut.

The exact penalties and taxes depend on the type of retirement account you have. Let's break down what that looks like for a 401(k), traditional IRA and Roth IRA.

401(k)

Withdrawing money from a 401(k) early comes with a 10% penalty.⁵ You also have to pay taxes on whatever you take out, but the IRS usually withholds 20% automatically.⁶ And if you take out a significant amount, it could bump you into a higher tax bracket.

So, if you took $20,000 from your 401(k) and that puts you in the 22% tax bracket, you may only get about $12,000–13,000 (depending on state income tax) when all is said and done.

Now, there are some exceptions to paying penalties on early 401(k) withdrawals (which we’ll dive into in a minute). But if you’re thinking about taking money out of your 401(k) to cover an expense or pay off debt, ask yourself this: Do I really want to borrow money at 30% interest? Of course not! And that’s basically what you’re doing when you dip into your 401(k) before retirement.

Traditional IRA

Whether you pronounce it eye-ruh or you sound out each letter, taking money out of a traditional IRA before you’re 59 ½ also results in a 10% penalty. There’s no automatic withholding like there is with a 401(k), but you still have to pay federal and state income tax on the amount you take out.⁷

Some exceptions can eliminate the early withdrawal penalty for traditional IRAs. But even if taking money out of your IRA seems like the easier option now, you’re going to regret it later.

Roth IRA

Since a Roth IRA uses after-tax dollars but grows tax-free (one of the reasons why we love it so much), you’re able to pull out any of your contributions, regardless of your age, without penalties or taxes. But if you want to take out any earnings (aka any growth from compound interest), you have to be at least 59 ½ and the Roth IRA itself has to be at least five years old. Otherwise, you must pay the 10% early withdrawal fee, plus any taxes.⁸

But the whole point of investing in a Roth IRA is that you won’t have to pay taxes when you withdraw the money in retirement. You already paid taxes on the money you’re putting in there, so why would you want to pay more by taking your money out too soon? You should take full advantage of a Roth IRA—and the best way to do that is to leave it alone until you retire.

What Are the Exceptions to the Early Withdrawal Penalty?

Just because you can avoid the 10% penalty, it doesn't mean you should take money out of your retirement account. Remember, even penalty-free withdrawals are taxed as ordinary income—and you still lose the future growth of every dollar you take out.

That said, the IRS does allow penalty-free withdrawals in certain situations.

Exceptions for Both 401(k) and IRA

• You use the money to pay for unreimbursed medical expenses (expenses that exceed 7.5% of your adjusted gross income).
• You had a child or adopted a child during the year (up to $5,000 is exempt for each account).
• You’re in the military and are called into active duty.
• The money is used to pay an IRS levy (a legal taking of property to pay back a tax debt).
• The money is divided into a series of substantially equal periodic payments (SEPP), also known as Rule 72(t). (This basically means you have to continually take out a certain amount from your retirement fund over time—and that’s determined by your account balance and life expectancy. Some people use this as a way to retire early.)
• You become permanently disabled.
• You die, allowing your beneficiaries to access your retirement funds.⁹

Exceptions for 401(k) Only

• You leave your job the year you turn 55 or later (50 for public safety employees).
• The 401(k) is divided in a divorce under what’s known as a Qualified Domestic Relations Order.
• You overcontributed to your 401(k).¹⁰

Exceptions for IRA Only

• The money is used for qualified higher education expenses (college tuition, room and board, books, etc.).
• The money is used toward the purchase or building of a first home (up to $10,000).
• The money is used to cover health insurance premiums if you’re unemployed.¹¹

Hardship Withdrawals

There’s also an exception to the early withdrawal penalty for a 401(k) called a hardship withdrawal. This lets you take money out of your 401(k) to meet an “immediate and heavy financial need,” according to the IRS.¹²

This could include repairing damage to your home after a natural disaster, covering funeral expenses for a loved one, or paying rent to avoid eviction. You’re only allowed to take out the exact amount needed for these expenses—and remember, you still have to pay taxes on it.

Unfortunately, hardship withdrawals are becoming more common, and some people are tempted to exaggerate their circumstances to qualify. Don't do it. Lying to get a hardship withdrawal is fraud, and it can lead to fines, tax penalties, losing your job and even jail time.

And even as it becomes easier to take money out of your 401(k), don’t forget you’re the one who has to live off that money when you retire. So be careful about what you call an emergency, and hold onto as much of your 401(k) as you can for later.

How Much Does an Early Withdrawal Actually Cost You?

The 10% penalty hurts. The taxes don't help. But the biggest cost of raiding your retirement is what you give up in future compound growth.

Here's what a $20,000 early withdrawal could look like:

_{*These examples were calculated using the Ramsey Investment Calculator. They're meant to illustrate the power of compound growth—not predict future investment performance. Actual returns will vary.}

As Ramsey Baby Steps Community member Walley put it, "Borrowing from your future self can be detrimental. Never ever borrow from your future self to satisfy yesterday's bad decisions. Besides, you won’t learn how to manage money doing it that way and will likely end up in the same situation down the road . . . with nothing left to fall back on!"

Use our investment calculator to see what your savings could look like if you leave them to grow.

What Does Raiding Your Retirement Really Cost You?

Raiding your retirement doesn't just cost you today—it robs your future self of compound growth that could be worth hundreds of thousands of dollars.

Ever heard the old proverb, “Let the sleeping IRA lie?” No? Just us? The purpose of retirement funds is to make sure you’re taken care of once you stop working and the income is no longer rolling in.

But too many people treat their retirement fund as their emergency fund. (Spoiler alert: They’re not the same thing.) And the more money you take out now, the less you’ll have for those beach-vacationing, golf-playing, grandkid-visiting days of retirement that you dream of.

When your 401(k) or IRA becomes an ATM, you lose out on all the money you would have earned with compound growth. Compound growth is your best friend—but only when you give it the opportunity to work. It’s not money for today. It’s money for tomorrow. Remember, investing is for the long haul, and it takes patience and self-control.

The long-term cost of looting your retirement fund is simply not worth it. Many people say they can make up for the loss by putting more money toward retirement later, but there are limits to how much you can contribute each year—both for 401(k)s and IRAs.

The last thing you want is to have to work harder and longer because you didn’t save enough for retirement. Leave your retirement accounts alone, and when the time comes to use them, you’ll be so glad you did!

Are 401(k) Loans a Good Way to Pay Off Debt?

No, a 401(k) loan is never a good way to pay off debt. With these loans, you’re technically borrowing from yourself and then having to pay yourself back—plus interest that ends up in someone else's pocket. No, thank you.

And 401(k) loans can backfire quickly. If you lose your job, your plan may require you to repay the loan in full. If you can't, the remaining balance becomes a taxable distribution with—you guessed it—the 10% penalty plus taxes.¹³ But the truth is, you can’t borrow your way out of debt, so you should steer clear of loans altogether.

How Can You Pay Off Debt Without Raiding Your Retirement?

The debt snowball is the best way to pay off debt without touching your retirement. Let's start there, then look at a couple other smart ways to speed up your debt payoff.

Use the debt snowball method.

When you’re up to your ears in payments, you need a game plan—and the debt snowball is it.

List your debts from smallest balance to largest, regardless of the interest rate. Make the minimum payment on everything except the smallest, and throw every extra dollar at that one until it’s gone. Then roll what you were paying on that debt into the next smallest balance and repeat. As each debt disappears, your momentum and motivation grows—and so does the amount you can put toward the next one.

One important Baby Step 2 rule to keep in mind: If you're in Baby Step 2 (paying off all non-mortgage debt), temporarily stop making new retirement contributions and redirect that money to your debt snowball. But never touch the money that’s already invested. Leave it alone so compound growth can keep working for you.

Cash out your non-retirement investments.

Wait a minute. Didn’t we just say not to use your investments to pay off debt? Yes and no. We don’t want you to touch your retirement fund. But non-retirement investments are a whole different story. Things like certificates of deposit (CDs), savings bonds, single stocks, gold and crypto aren’t doing you any favors. Cash those babies in and use the payout to knock out some debt!

Get on a budget.

If you’re overwhelmed by debt, start with something simple: a budget. Having a written plan every month will help you get on top of your debt payments and actually make progress toward paying them off. In fact, budgeting is the best way to take control of your money—no matter how much you make. Download the EveryDollar budgeting app for free to create your budget now.