Author Topic: Should they sell off Trad IRA to pay off debts?  (Read 4058 times)

RetireAbroadAt35

  • Stubble
  • **
  • Posts: 222
Should they sell off Trad IRA to pay off debts?
« on: August 07, 2015, 08:34:45 PM »
History: http://forum.mrmoneymustache.com/ask-a-mustachian/case-study-spreading-the-good-word

So the folks in question are on a debt repayment snowball, tackling highest interest first.  They used a couple of 0% balance transfers to buy some time on credit cards while they throw some big wads of cash at them.  Nothing new is going on the cards and the situation is slowly getting better.  However, I'm wondering if it would make sense for them to sell off some of their traditional IRA accounts and use it to pay the high-interest debts off. 

Some details:
  • He is eligible by age to sell w/o penalty
  • His traditional IRA balance is $28k. 
  • Credit card balance is currently $9400 and will revert to high interest rates in a few months
  • Child's student loan is $7500@7.9%
  • Car is $7500@4.5%
  • Net household income is ~$72k, half of which is VA disability

Selling part of the IRA means increasing taxable income.  I'm not sure what their taxable income is, however, a google search tells me VA disability is not taxable, so I'm assuming the IRA sale would not cause much tax burden.

The only downside I see is the opportunity cost from losing out on investment returns.

What else should I consider?

CabinetGuy

  • Stubble
  • **
  • Posts: 109
Re: Should they sell off Trad IRA to pay off debts?
« Reply #1 on: August 08, 2015, 12:23:19 PM »
Don't.  Just don't.  I'm not the most financially literate person on this site, I'll admit.  But I have cashed in small 401(k)s in the past to pay off bad debt.  And guess what?  I regret it now that I have my shit together. 

Sounds like they have it under control and they are on their way to being debt free.  So why touch it?

Jon

Cpa Cat

  • Handlebar Stache
  • *****
  • Posts: 1617
Re: Should they sell off Trad IRA to pay off debts?
« Reply #2 on: August 08, 2015, 12:39:51 PM »
Absolutely not.

Given that you don't know what their AGI is, you really have no idea what the consequences could be. Earned income credit? Subsidies? Low income refunds from the state?

Secondly, I think it's a bad idea to treat retirement savings as a pot of money to raid for purchases/debt. People do it all the time, but it's almost always a bad idea. It bandaids over the problems that created the debt at the expense of future security.

And people tend to willfully forget about it - repeating mistakes of the past, choosing not to report it on their taxes because they don't remember doing it. Don't ask me why - the psychology behind raiding retirement accounts is twisted. Don't go there.

frugaliknowit

  • Handlebar Stache
  • *****
  • Posts: 1671
Re: Should they sell off Trad IRA to pay off debts?
« Reply #3 on: August 08, 2015, 12:52:06 PM »
The short answer is NO.  The long answer is we don't have enough information.  Generally, unless the sheriff is about to take the house and there's no alternative, the answer is still NO.

The first thing they need to figure out is why there's this:

Credit card balance is currently $9400 and will revert to high interest rates in a few months
Child's student loan is $7500@7.9%
Car is $7500@4.5%


and Stop the bleeding and have a plan to pay this off and live within their means.

forummm

  • Walrus Stache
  • *******
  • Posts: 7396
  • Senior Mustachian
Re: Should they sell off Trad IRA to pay off debts?
« Reply #4 on: August 08, 2015, 02:15:21 PM »
Quote
They used a couple of 0% balance transfers to buy some time on credit cards while they throw some big wads of cash at them. 

So these balances are after taking out these 0% balance transfers? Sounds like they need to get serious about cutting down their big spending. If they pull from their IRA, they could very easily just fill up the cards again.

Looking back at the original case study, it looks like their mortgage is tiny. Why not refinance with cash out to wipe out all their high interest debt and lock in a lower interest rate? A 6% mortgage is ridiculous with today's rates. They could probably get a 2-3% VA loan.

Frankies Girl

  • Magnum Stache
  • ******
  • Posts: 3031
  • Age: 82
  • Location: The laboratory
  • Typical Ghoul Next Door
Re: Should they sell off Trad IRA to pay off debts?
« Reply #5 on: August 08, 2015, 03:09:41 PM »
And a big hell no should they be paying off their CHILD'S STUDENT LOAN!!!!!!

(!!!)


The child should foot that bill. So no, robbing their retirement to pay for something that the full grown adult that has literally a lifetime to pay that back (but hopefully will get off their ass and pay it sooner than that) is the stupidest move they could make (and the child should be ashamed of themselves if they entertained the idea themselves).

And yes, they need to come down hard on their spending, sell the damned car for a clunker and refi the house (or move to a smaller place) and stop racking up charges they do no have the money to pay for.

I just re-read the case study and this is bullshit:

Until about 10 years ago, they were pretty debt-averse, but somehow credit card balances climbed, a high-interest student loan was taken, and new (but sensible) cars were financed.


They got stupid with their money and are making excuses, like some magical thing happened and suddenly they were saddled with all this debt. They need to own up to making poor decisions, or else they'll just keep making them since without recognizing and taking responsibility they'll just keep blaming someone/thing else and keep right on trucking down that road o' debt.

« Last Edit: August 08, 2015, 03:14:47 PM by Frankies Girl »

forummm

  • Walrus Stache
  • *******
  • Posts: 7396
  • Senior Mustachian
Re: Should they sell off Trad IRA to pay off debts?
« Reply #6 on: August 08, 2015, 06:37:12 PM »
And a big hell no should they be paying off their CHILD'S STUDENT LOAN!!!!!!

OP does say "child's" loan here, but in the case study OP says it's a "parent's PLUS loan".

Bumbling Bee

  • Stubble
  • **
  • Posts: 184
  • Location: New York City
    • Journey of a Thousand Face Punches
Re: Should they sell off Trad IRA to pay off debts?
« Reply #7 on: August 08, 2015, 07:15:26 PM »
I'm with everyone else on the H-E-L-L NO to cashing out the IRA. How much can they throw at the debt each month? Assuming they've cut back significantly from the spending in the case study, they should be able to pay off the credit card pretty quickly. Also, did they get rid of one of the cars, or do they have both? Selling the newer Honda would help a lot, and I would think would be a better option than giving up about 20% of their retirement assets (working off the numbers in the case study).

RetireAbroadAt35

  • Stubble
  • **
  • Posts: 222
Re: Should they sell off Trad IRA to pay off debts?
« Reply #8 on: August 10, 2015, 08:55:14 AM »
Put down the pitch-forks and speak to me with math.

He's at retirement age.  Why shouldn't he be using his IRA if his AGI is low?  I don't know what it is but I'm going to find out. 

Since there are no penalties for selling, why not use some of it to kill off a 7.9% interest parent plus loan?   Once that loan is eradicated, they can go back into savings mode.
« Last Edit: August 10, 2015, 09:18:44 AM by RetireAbroadAt35 »

Bikeguy

  • Stubble
  • **
  • Posts: 123
  • Location: Ann Arbor, MI
Re: Should they sell off Trad IRA to pay off debts?
« Reply #9 on: August 10, 2015, 11:43:47 AM »
Will the couple develop discipline and not use money they don't have in the future?   If they can answer yes, and follow through, and will save more than they pull out,  then yes.

However,  past behavior best predicts future behavior,  so more than likely,  they will drain the IRA and run up more debt.

So,  I'd advise against it.

The fact he's at retirement age,  or can draw without penalty, and has 28K total. saved tells the entire tale. That and the roughly equivalent  amount of debt than savings.

Sent from my SCH-I545 using Tapatalk

Rosy

  • Handlebar Stache
  • *****
  • Posts: 2128
  • Location: Florida
Re: Should they sell off Trad IRA to pay off debts?
« Reply #10 on: August 10, 2015, 12:17:27 PM »
Quote
He's at retirement age.  Why shouldn't he be using his IRA if his AGI is low?  I don't know what it is but I'm going to find out. 
   

Why should he kill off part of the golden goose for a quick fix? It is not a smart move, in fact, it is a scary move, because that money is basically meant to provide a living for many years to come. They are of an age where it will be hard to replace that money if at all - throwing it at debt is not a good idea - it robs them of income down the line.
At the very least it is a semi liquid emergency fund - this debt, giving their particular circumstances and their age is not an emergency.
 
It makes more sense to sell the second car, if they are looking for a quick fix now. But I dare say that it will make no difference in the long run. 

Bottomline, they need to keep it simple: Stick to the snowball system and lo' and behold those cc's will be paid off, one by one, and so will the SL - without ever touching their nest egg.

I am retirement age and retired and I will say this, if I were them, I would be a lot more worried about the cost of health insurance for her when she retires in four years. I would make it my priority to have as much of a stash as possible come retirement day. That cc debt will take care of itself - stick with the snowball, decide on a comfortable payment that will still allow savings, focus on not adding any more debt and don't touch that IRA. PROTECT that nest egg at all cost.

RetireAbroadAt35

  • Stubble
  • **
  • Posts: 222
Re: Should they sell off Trad IRA to pay off debts?
« Reply #11 on: August 10, 2015, 05:05:42 PM »
However,  past behavior best predicts future behavior,  so more than likely,  they will drain the IRA and run up more debt.

I hear what you're saying, but I'm not looking to philosophize, prognosticate or psychoanalyze.  To me that's tilting at windmills.  My goal is simply to understand the numbers and model a couple scenarios.  It'll be up to them to stick to the plan.

Quote from: Rosy
Why should he kill off part of the golden goose for a quick fix?
How is it his golden goose when he's paying more in loan interest than he's earning on portfolio returns?

Here's the way I look at it.

If they follow the current debt paydown plan, they'll spend ~$16.2k over the next 14 months.  If, however, they sell part of their IRA retirement savings, they'll pay ~$15.7k today.  They would free up ~$1100 in montly cash flow to redirect back into savings, which could replenish the IRA (now split between his and hers) in about 14 months.  Given that much of his income isn't taxable (VA disability) he it should be close to neutral on taxes and deductions.  Given their likely low AGI, they would be essentially tax-gain harvesting the IRA.  Win win.

The risks I see are:
1) He could miss out on a bear market that kicks off tomorrow.  Not likely.
2) One of them could croak before replenishing the IRA.  Term life insurance pay-out is worth more than the $15.7k.
3) They could go on a wild spending spree and waste the $1100 a month.  That's their choice but I don't see this as an issue.

Is my math or understanding of the tax rules incorrect?

RetireAbroadAt35

  • Stubble
  • **
  • Posts: 222
Re: Should they sell off Trad IRA to pay off debts?
« Reply #12 on: August 10, 2015, 08:04:01 PM »
I thought IRA distributions after 59.5 would have been treated like long-term capital gains.  However, the entire distribution is treated as ordinary income.  That changes the game a bit.

I estimated that their income taxes would increase by $100-1700 depending on their AGI, and assuming they replenished the accounts (he's under 70.5).  Their interest savings would not that great given how close they are to paying off these debts.

So unless their AGI is under $24k I don't think the math works.

The question is, would the cost of those increased tax be worth the peace-of-mind.  I think they will say no.

Looking back at the original case study, it looks like their mortgage is tiny. Why not refinance with cash out to wipe out all their high interest debt and lock in a lower interest rate? A 6% mortgage is ridiculous with today's rates. They could probably get a 2-3% VA loan.
They need the cash for home repairs - some of which could become emergency fixes before winter.  Given that they could pay off the current loan in ~3 years under the current plan, would it really make sense to take out a 15-30 year mortgage?


Bikeguy

  • Stubble
  • **
  • Posts: 123
  • Location: Ann Arbor, MI
Re: Should they sell off Trad IRA to pay off debts?
« Reply #13 on: August 12, 2015, 10:57:57 AM »
Just because you get a 15 year loan doesn't mean you are required to pay it off in 15 years.   Switch to 3% 15 year loan and make big enough payment to pay it off in 3.

Sent from my SCH-I545 using Tapatalk