Debt Solutions

From LoveToKnow Creditcards

When you are in debt, having an understanding of debt solutions is key to recovery. While there are many forms of debt solutions, it helps to have prior knowledge of the options available before your debt grows out of control.

Learn tips for credit card debt elimination

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Debt Solutions: Options for Recovery

Getting out of credit card debt is hard work. With so many Americans in debt, countless ways of managing that debt have sprung up. Some common forms of debt solutions include:

Self-Management (involving budgeting and paying down credit cards)
Consumer Credit Counseling
Debt Settlement
Debt Consolidation
Borrowing from Retirement Accounts (only available to some accounts for certain reasons)
Bankruptcy

While most people have heard of bankruptcy, consolidation, settlement, and counseling, few know the rules when it comes to borrowing from retirement accounts. This kind of solution requires knowing a lot about your retirement plan and figuring out whether or not it is a solution that will work for you.

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Pros of Retirement Account Borrowing

Only certain retirement accounts are eligible for loans or withdrawals. Qualifying plans usually include pension plans, 401(k) plans, and 403(b) plans. However, check with your benefits personnel to find out the rules that apply to your account.

Most accounts will only let you borrow up to $50,000 or 50 percent of the amount you invested. While the tax code does state you can get up to $10,000 regardless of your invested amount, additional security is needed to get the loan. For this reason, it is not frequently done.

Some of the reasons to borrow from your retirement account include:

Up to five years to pay back the loan before IRS fees and taxes will be charged
Taking out a loan with a retirement account guarantees a rate of return, since you are basically paying yourself back
For those with significant credit card debt, the loan interest rate may be less than the credit card interest rate, making the loan worth it

Of course, this is all contingent on the fact that you include the repayment amount into your budget, because severe consequences may occur if the debt is not repaid.

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Cons of Borrowing from Retirement Accounts

Most financial planners caution against borrowing from your retirement account. The Department of Laborsuggests to avoid permanent withdrawals, as they may be subject to anywhere from a 10 to 39.1 percent tax penalty and another 10 percent penalty if withdrawn before age 59 and a half. State taxes may have to be paid as well. For this reason, make sure you have a loan and not a permanent withdrawal.

Other cons of withdrawing from your retirement account include:

Retirement account will not grow as quickly
The interest earned on the loan may be less than can be made in other investments
Loan repayments involve money that will be taxed twice (the repayment will be made with money that is taxed, and then the money will be taxed again when withdrawn)

However, the double taxation may still end up costing you less than the interest paid when it comes to serious credit card debt, where interest rates may run as high as 18 or 21 percent for delinquent accounts. Loans against a retirement account can often be taken at lower than 10 percent interest.

Failure to repay the loan on time or in the full amount can result in severe penalties. The loan is then considered a permanent withdrawal and taxed accordingly. Additionally, most people have spent that borrowed money and do not have it available to pay the taxes.

If you do not think you can pay the loan back in the stated amount of time, you should not take out the loan. Or, if there is a chance you may quit or be terminated from your job where your retirement account loan is held, you should not take out the loan. Quitting or termination automatically makes the loan balance to be considered unpaid and subject to penalties and taxes.

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Staying Debt Free

Before taking out a retirement account loan, speak to a financial planner and your human resources counselor. Some debt solutions can cause credit scores to be lowered. But for some people with serious debt, debt solutions like retirement account loans can be the answer. However, it should not be gone into lightly. Consider the consequences of any debt reduction plan before moving forward.

Once your debts are paid off, you should take pains to make sure you stay debt free. Keep spending below your income, and practice what you learned while getting out of debt. Do not use your credit card(s) unless it is an emergency and cut up store credit cards.

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