Using Traditional IRA Funds to Pay Off Debt

In response to my recent post about Roth IRA withdrawal penalties, a reader named Aaron asked the following:

My wife has $40k in a traditional IRA. It was a rollover from when she used to work. We have about $40k in debt (cars, credit cards, school loans) plus a mortgage. Is there any way to pull the money out to pay off this debt without huge penalties?

Unfortunately, the answer is “no” — not unless Aaron’s wife is at least 59.5 years old, that is. Except under specific circumstances, younger individuals cannot touch IRA funds without getting walloped by that 10% early withdrawal penalty plus any applicable taxes.

In other words, they’d face a $4k penalty plus a ton of taxes if they were to access the money for debt reduction right now.

This is all covered in greater detail in IRS Publication 590, but the exceptions to the 10% penalty include distributions:

• Made to a beneficiary or estate on account of the IRA owner’s death,
• Made on account of disability of the IRA owner,
• Made as part of a series of substantially equal periodic payments for your life (or life expectancy) or the joint lives (or joint life expectancies) of you and your designated beneficiary,
• Qualified first-time homebuyer distributions,
• Not in excess of your qualified higher education expenses,
• Not in excess of certain medical insurance premiums paid while unemployed,
• Not in excess of your unreimbursed medical expenses that are more than a certain percentage of your adjusted gross income,
• Due to an IRS levy, or
• Due to a qualified reservist distribution.

Once you hit 59.5, you are welcome to begin taking distributions for any reason without paying the 10% penalty, though you will still be on the hook for any applicable taxes — this is a traditional IRA. Given that it was from a 401(k) rollover, I’d be willing to bet that the money in the account is all tax deferred.

Something else to consider: Tax advantaged accounts are powerful tools for building wealth, and your contributions to them each year are limited. Thus, it’s hard to rebuild them once you pull the money out. I would think long and hard before liquidating such an account to pay off debt.

As we’ve talked about previously, if this was a Roth IRA, Aaron’s wife would be free to pull out any contributions for whatever reason without tax consequences. And she’d be free to take out any conversions as long as the account had been in place for at least five years.

Of course, the same considerations regarding contribution limits and the difficulty of rebuilding such an account after liquidating apply to Roth IRAs just the same as traditional IRAs.