Is it ever okay to liquidate your 401K?

Confession: Recently, I've been on bad credit card behavior.

So in pondering how I would correct this problem, I seriously, for a 10th of a mille-second, thought about liquidating my 401K (well partially at least, since I probably wouldn't need the whole thing) to completely alleviate the credit card debt I've mischievously racked up in the 2012.

Then a conversation with a colleague-friend came up today about how people finance their living arrangements when they leave a full time job to pursue an MBA at a full time 2 year program. I was naive enough to think that these people just saved up while they were working and accumulated enough to live a "college" lifestyle while they're off the job for 2 years. My colleague-friend quickly corrected me by saying something to the tune of, "Yeah, I used to be like you, and wanted to think people had it all together, but the truth is they usually liquidate their 401Ks to live off of."

This NEVER occurred to me! But since it was brought to my attention, I wondered whether I agreed or disagreed with this method of financing...for the MBAers and credit card spenders like myself.

Unfortunately, I am still undecided. Well, I sort of agree that you shouldn't liquidate...but I understand why people do. In the grand scheme of things, I don't think it would be that detrimental to one's retirement to take $10K- 15K out to alleviate some stress early on in their career. But! This should only be a SINGLE quick fix... not something you do every 5 years. This is a one time deal. And that's where it gets iffy for me because chances are, if it's that easy for you to swim out of your credit card debt, how likely are you be to get right back in it... probably pretty likely.


In reading about it, I didn't find one finance guru who supports liquidating your 401K for any reason other than the absolute last means of survival. Their reasons why:

• Your retirement fund is the ONE thing that creditors can not get to (in most states) even after you file Bankruptcy. Why give them access to cash they are not permitted to go after under any circumstances.
• If you're under 59 1/2 years old, not only does a retirement distribution get taxed as ordinary income (at your individual tax rate) but you also incur a 10% penalty for early withdrawal. While credit card debt can have pretty harsh interest rates, you end up paying a much higher percentage on an early distribution and this almost always outweighs your credit card's interest rate.  
• There's ALWAYS something else you can do first. Instead of going straight for the 401K, you should make changes in your budget in order to live within your means. This way, not only do you dig yourself out of a hole, but you also teach yourself how to stay out of it. Until you have exhausted every other option you should not touch your 401K.

Now that I've written it all...I guess I have ruled this one out...

But...there are reasons you can borrow from your 401K...but the key word there is borrow. We shall talk about that next time.

Until then...

peace.love.soul.

Trick AND Treat

Yeah, yeah, I know it's Valentine's Day and not Halloween but the title just fit better. Additionally, while I don't consider myself to be a bitter single woman, I don't think of Valentine's Day as some super fantastic addition to my world....mostly because I believe we should be spreading love every single day...not just once a year. But I guess that goes for most holidays...

I digress. Recently, as you all may know, I've been really focused on managing my money correctly since becoming a full time working woman. Since July 2010, I've reduced a lot of my monthly costs in order to allow me to save more money and reduce debt. However, most recently, as in the past few weeks...I've been on this spending frenzy. Well...I'm not sure that's what you'd call it but whatever it is, it ain't good. It hasn't really hurt anything too badly, it has just forced me to slow down on my massive savings revolution...which makes me sad.

I think I'm starting to realize that I have these financial roller coaster rides....where for a few months I'll be doing spectacular (and sometimes I'm not even sure what I'm doing to make the money flow like it does) and then for another few months, I will need to watch what I'm spending like a hawk, as to not overextend myself because I'm thisssss close. I hate those months. They make me nervous. Does anyone else have this problem?

My financial personality, as I'd like to call it, makes me the type of person who always thinks the worst is going to happen..I think they call this pessimistIC. So if I feel like my emergency cushion isn't all there, I'm freaking out when I don't have a really big threshhold for error, which is usually the case in the down months. Sometimes...I just need to check myself.

So while I stumbled upon this video on CNN Money, I was excited to share with you all. Some guy (he didn't say anything about himself) was advising ways to "Trick Yourself Into Saving More." I thought maybe we could all try to implement these and see how it helps or hinders our progress:

1) Put Savings on Autopilot - this includes automatic deposits into your 401k, IRAs and your savings account. I definitely do this now...I cannot count on myself to manually transfer money every month from one account to another. Automatic transfers have become my best friend.

2) Dangle a Carrot - now this was interesting to me because I kind of do this...but I think I need to do it a lot better. hahaha. Dangling a carrot involves setting a savings (or debt payment) plan with a reward once you've achieved the goal. For instance:

Goal: if I can increase my savings by $5,000 by June,
Reward: I'm allowed to purchase a new really expensive bag I've been eying.

I think usually I start here...but at some point, when I'm on my way to the reward, I convince myself I've done well enough to get the reward now...lol. Not to mention, if I want something now (say a new bag, shoes, etc), why would I still want the same thing in June...there will be something new for me to want and it could be completely out of season. So maybe I should try smaller rewards along the way that lead up to a large one? It's like eating 6 small meals a day to effectively diet instead of starving yourself all day and then binging on one huge meal. *just had an a-ha moment*

3) Use a Stick - so this is the opposite of dangling a carrot and I'm not sure would ever work for me but maybe some of you respond better to punishment rather than reward. The idea behind this is to make yourself a commitment contract. If you don't hold up to your end of the bargain, you have to pay a fine (I guess to your savings???) or punish yourself in some sort of way. Yeah...punishment de-motivates me so I'm going to stick with the carrot.

4) Focus on the Big Stuff - in general, when looking for ways to cut costs and save money focus on the big stuff...get a smaller apartment instead of the larger one, buy a used car instead of a new one, etc etc.

I have definitely done this in the past year. I yearn so badly for my own one bedroom in Chicago...but I'm sticking with a roommate for the time being because my costs are greatly reduced and it allows me to save more and pay down more debt. Not to mention that most of the time I absolutely love my roommate. Even still, frequently I scour Craigslist and rental agencies looking at apartments. In the end I'm always forced to remember that I can have that, AFTER I reach my savings goals. I guess this encompasses a little carrot dangling too.

On the car aspect of this...I completely failed.

Next...

Snowballll Fiiiiight!

Honey, it's snowing outside!

In the spirit of snow, I thought I would write a post on snowballing. Ironically when I googled this, some really ridiculously nasty sexual practice came up...please note, I will not be discussing that type of snowballing in this post. I learned about this concept back in grad school. Snowballing is a popular method of paying down debt quickly and has been made popular by Dave Ramsey, a financial guru type fella with books and his own tv show. It's the concept of paying down debt by paying off the smallest debts first and eventually allowing your payments to snowball to become debt free.

Here's Dave explaining the Debt Snowball:


hahaha gotta love Dave's enthusiasm. So it works like this: (this is a simple example I got from wikipedia that does not take into accruing monthly interest)

A person has the following amounts of debt and additional funds available to pay debt (the debt is listed with the smallest balance first, as recommended by the method):
Credit Card A - $250 balance - $25/month minimum
Credit Card B - $500 balance - $26/month minimum
Car Payment - $2500 balance - $150/month minimum
Loan - $5000 balance - $200/month minimum
The person has an additional $100/month which can be devoted to repayment of debt.

Under the debt-snowball method, payments for the first two months would be made to debtors as follows:
Credit Card A - $125 ($25/month minimum + $100 additional available)
Credit Card B - $26/month minimum
Car Payment - $150/month minimum
Loan - $200/month minimum

After two months (presuming the person has not added to the balances, which would defeat the purpose of debt reduction), Credit Card A would have been paid in full, and the remaining balances as follows:
Credit Card B - $448
Car Payment - $2200
Loan - $4600

The person would then take the $125 previously used to pay off Credit Card A and apply it as additional payment to the Credit Card B balance, which would make payments for the next three months as follows:
Credit Card B - $151 ($26/month minimum + $125 additional available)
Car Payment - $150/month minimum
Loan - $200/month minimum

After three months Credit Card B would be paid in full (the final payment would be $146), and the remaining balances would be as follows:
Car Payment - $1750
Loan - $4000

The person would then take the $151 previously used to pay off Credit Card B and apply it as additional payment to the car loan balance, which would make payments as follows:
Car Payment - $301 ($150/month minimum + $151 additional available)
Loan - $200/month minimum

It would take six months to pay the car loan (the final payment being $240), whereupon the person would then make payments of $501/month toward the loan (which would have a $2800 balance) for six months (with the last payment at $234).

Thus in 17 months the person has repaid four loans, with two of them being paid in a mere five months and three within one year.

Now the point of snowballing is to pay debts off in the order of balances. There is also something called avalanche-ing which pays debts off in the order of interest. The differences between these two methods is that you pay more interest but pay debt off quicker with snowballing and you pay less interest and it takes slightly longer with avalanche-ing. Another reason snowballing is favored over avalanche-ing is because, mentally, you get a sense of encouragement from paying off debts every few months.

Linked here is a free spreadsheet that helps you keep track of your snowballing debt plan (complete with tabs and formulas already there). Click the download now button on the right.

This is REALLY useful if you're trying to get rid of multiple debts. Snowball away!