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Debt and a 401(k) loan
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December 1, 2000: 11:38 a.m. ET
Swimming in credit card debt? Think hard about dipping into your 401(k)
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NEW YORK (CNNfn) - Your credit card debt is going through the roof while your 401(k) plan seems to be skating along nicely. Should you borrow from your bulging retirement plan at work to pay off those pesky credit card bills?
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VIDEO
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 Doug Flynn, a certified financial planner, answers questions on Your Money's viewer mail segment. |
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And maybe you're a long-term investor wondering how high-yield bond funds play a role in your portfolio?
Doug Flynn, a certified financial planner in Garden City, NY, said investors should tread carefully when thinking about dipping into the nest egg. Flynn recently appeared on CNNfn's Your Money, and answered questions via e-mail for CNNfn.com.
Every week, CNNfn.com brings you video from Your Money, where experts answer your questions about financial planning issues. If you have a question, you can e-mail the show at yourmoney@cnnfn.com.
John writes: I have approximately $40,000 in my 401(k) that has been performing pretty well. I have been maxing out my contribution to it for about four years and I just turned 29. I also have about $25,000 in credit card debt that I am paying off. I have a great payment history and have been playing the game of moving my balance from card to card based on the lowest APR, which has helped stop some of the bleeding. I am no longer using revolving credit cards for anything and have learned my lesson. My question to you is, should I get money out of my 401(k) to pay off all of my credit card debt? Although the average return on my 401(k) is higher than the 12.9 percent or so I pay on my credit cards, I feel if I pay off the cards, I could invest the $500 a month that I am paying towards my credit card debt and build my portfolio back up quickly.
There are several issues surrounding the decision to borrow money from your 401(k) in order to pay off your credit cards.
The first thing you will need to find out is: Does your 401(k) plan have a loan provision, and does it allow you to continue making deductible contributions to the plan while you have an outstanding loan? Some plans have restrictions. Also, you need to know what the interest rate is on the loan. Assuming you can continue contributions and the rate is favorable, it may make sense from a financial standpoint.
However, there is also an intangible "human factor" to this that most people do not count. You said you have learned your lesson and do not plan on using revolving debt in the future, which is great. However, our experience has shown that many people tend to allow their credit card balances to creep right back up.
This is often due to those unexpected emergencies or opportunities that seem to pop up from time to time. Remember, you amassed $25,000 in debt because you were spending more than you were earning. If you haven't made some real lifestyle changes (or you have not dramatically increased your income), you may find yourself squarely back in the same predicament you were in before. Only then, you will have $25,000 in credit card debt, AND a large 401(k) loan to contend with.
The bottom line is: only you know yourself and your tendencies. As a result, our advice is to proceed with caution. Good luck.
Do you have a question about whether you can afford to stop working? E-mail our experts at retirement@cnnfn.com.
Stan writes: Ten years ago I invested in a high-yield mutual fund at $3.44 a share. During the Milken trouble, (the so-called "junk bond king who went to prison for securities fraud in the 1990s), it dropped to $2 a share and I bought some to a total of $38,000. It never went back to over $3 a share. I reinvested all dividends and I now own 29,000 shares. It has done very badly the last year. I could sell at a $24,000 profit. I could take the income at $635 a month or just leave it as it is. I would very much like your advice. I am 76 years old.
You should be commended for your commitment to long-term investing. However, a quick unscientific guess tells me that your investment return on the fund has probably been less than 6 percent annually!
You should check with the fund family directly to find out exactly what your net rate of return has been. You can also check Morningstar data to get an idea of how this fund has performed in its peer group. (Click here to generate a Morningstar fund report on CNNfn.com).
If it turns out that this net rate of return is correct, it is certainly not great considering the extreme volatility you have experienced. After all, the other common name for a "high yield" mutual fund is a "junk bond" fund.
My recommendation on what to do with this fund would depend on several factors. First of all, what is your goal for these funds? If you need income perhaps you could reallocate to a better performing bond fund with less risk. If you do not need this money for some time, then perhaps a more diversified mix of several income, balanced and/or equity mutual funds might work for you.
Either way, I know you recognize the importance of keeping an eye on each of your investments from time to time, but trying to maintain a level of diversification so you do not have all your eggs in one basket for such an extended period of time is equally important. Good Luck. 
* Disclaimer
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