Does it ever make sense to withdraw Roth IRA contributions to reduce credit card debt?

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observata
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Does it ever make sense to withdraw Roth IRA contributions to reduce credit card debt?

Post by observata » Thu Mar 08, 2018 3:11 pm

I'm trying to understand and reconcile (or prioritize) two conflicting pieces of advice, and I'm wondering if someone better at math can help me think it through.

- Principle #1: Pay off high-interest debt before saving or investing at a lower interest rate.
- Principle #2: Avoid withdrawing from retirement accounts to pay down debt.

These seem irreconcilable. Under Principle #1, if I have $5k in available cash, I should use it to pay down credit card debt (APRs ranging from 14-24%). Under Principle #2, if I already put that $5k in a Roth yesterday, I should just leave it there.

In the context of Roth contributions (which can be withdrawn penalty-free), the act of contributing $5k today and the act of not-withdrawing $5k today seem identical. So Principle #2 would suggest not only leaving the current contributions alone, but also putting the $5k cash into the Roth before the April deadline for 2017 contributions and deferring some debt payments until later.

Please include some explanation and analysis (or links to relevant reading) rather than just bottom-line opinions. I have read many books on personal finance and am trying to develop a deeper understanding of the mechanics—no self-help pointers or sermons, please.

In case it matters, I am in my early 30s, recently started having a high income (> $200k per year before taxes), and have $72k in traditional and Roth IRAs ($16k in the Roth). But I also have very high debt, including about $65k in credit-card debt and > $330k in federal student loans. So I have both oversaved and overspent in the past. l now earn roughly $3k-4k per month that I can use to pay down debt or invest.

Other potentially relevant considerations:

- My credit score sucks because of the amount of debt and the debt-utilization ratio, but I have never missed a payment.
- Because of my recent income increase, 2017 is likely the last year that I can make Roth contributions without rollovers (does that matter?). Once contributions are withdrawn or a given year's contribution period expires, that opportunity is permanently lost.
- The Roth contributions could conceivably serve as a true "emergency fund"; on the other hand, (1) improving my credit score and getting access to credit at reasonable rates again could serve the same function, and (2) that high-interest credit card debt is itself an "emergency" and would make any other emergency unmanageable.
- The credit card debt is creating a lot of stress for me. For example, it makes me feel that losing my job would be a financial catastrophe.
- Since I have so much higher-interest debt, my student loans have long been in forbearance and I am putting off making any payments (but the interest is not capitalizing). On a standard student loan repayment plan, my monthly payment would be over $3,700 per month.

I appreciate your thoughts. I would especially appreciate an answer that would help me make a spreadsheet or otherwise improve my understanding.
Last edited by observata on Thu Mar 08, 2018 3:53 pm, edited 2 times in total.

miamivice
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Re: Does it ever make sense to withdraw Roth IRA contributions to reduce credit card debt?

Post by miamivice » Thu Mar 08, 2018 3:17 pm

While I'm not going to create a spreadsheet and do the calculations, at standard credit card interest rates (often 14 - 18% interest), it's a slam dunk to withdraw contributions from a Roth IRA to pay it off. You free up cash flow that might be earning 5 - 8% ROI to pay off debt that is costing ~15% ROI.

With that said, the risk is the available credit line on your card might tempt you to spend more. If you end up overspending again, then you've robbed your retirement for little benefit. I can't quantify that risk on a spreadsheet, that risk is only known to you.

observata
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Re: Does it ever make sense to withdraw Roth IRA contributions to reduce credit card debt?

Post by observata » Thu Mar 08, 2018 3:34 pm

miamivice wrote:
Thu Mar 08, 2018 3:17 pm
While I'm not going to create a spreadsheet and do the calculations, at standard credit card interest rates (often 14 - 18% interest), it's a slam dunk to withdraw contributions from a Roth IRA to pay it off. You free up cash flow that might be earning 5 - 8% ROI to pay off debt that is costing ~15% ROI.
Thanks! Edited the post to make clear that I'm not asking someone else to make a spreadsheet for me. I am good with Excel but do not have a complete understanding of the relevant math, especially how to quantify the opportunity cost of Roth withdrawals.

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BL
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Re: Does it ever make sense to withdraw Roth IRA contributions to reduce credit card debt?

Post by BL » Thu Mar 08, 2018 3:48 pm

I would suggest you are over-thinking this rather than acting on this emergency.

List, at least for yourself, all separate debts, their interest rates, and monthly payments. Later calculate how long it will take to pay each off at current payments and what the total cost will be.

Order them from highest rate to lowest.
Also order them (>10% interest) from smallest to largest.
Start paying off in one order or the other. A small debt payed off means you can use that extra payment on the next debt, Dave Ramsey's "snowball" effect, which lets you see progress more quickly.

List your current budget; then see what you can cut. At 200k gross, there should be a lot more to pay off loans. Cut everything to the bone for now, so you can get the worst taken care of. It makes no sense to invest when you are paying 24% interest, except possibly for matching funds if available.

Get Dave Ramsey's book on getting rid of debt.

I wish you Success!

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FiveK
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Re: Does it ever make sense to withdraw Roth IRA contributions to reduce credit card debt?

Post by FiveK » Thu Mar 08, 2018 3:49 pm

observata wrote:
Thu Mar 08, 2018 3:11 pm
I'm trying to understand and reconcile (or prioritize) two conflicting pieces of advice, and I'm wondering if someone better at math can help me think it through.

- Principle #1: Pay off high-interest debt before saving or investing at a lower interest rate.
- Principle #2: Avoid withdrawing from retirement accounts to pay down debt.
The difference is in the highlighted adjective.

Investment Order may be worth reading.

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Watty
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Re: Does it ever make sense to withdraw Roth IRA contributions to reduce credit card debt?

Post by Watty » Thu Mar 08, 2018 3:50 pm

observata wrote:
Thu Mar 08, 2018 3:11 pm
I am in my early 30s, recently started having a high income (> $200k per year before taxes)
......
l now earn roughly $3k-4k per month that I can use to pay down debt or invest.
You are asking the wrong question. The problem is not how to juggle money it is how to spend less so that you have more disposable income.

A few years ago your income was a lot lower and you lived OK(except for running up credit card debt) when you were living on a lot less. For example if you were living on $60K a year a few years ago then you now have an extra $140K in income. A lot will go to taxes but if you pretty much lived like a student for a bit longer you could have the credit cards paid off well before the end of the year.

You might want to post the details of your monthly budget and where all the money is going so see if you can get some suggestions on where you might be able to free up more money.

aristotelian
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Re: Does it ever make sense to withdraw Roth IRA contributions to reduce credit card debt?

Post by aristotelian » Thu Mar 08, 2018 3:54 pm

Pay off the debt. If you leave the funds in Roth, you have average expected return of 10% with a lot of risk and fluctuation, combined with a guaranteed drag of -20%. Generally you will be losing money to the debt. I would rather pay off the debt and have 0 invested with 0 debt.

To put it in perspective, last year was I am guessing in the top quartile of annual total returns for stocks, maybe even better than that, and you would have barely broken even by staying in Roth. I would not bet on a year like 2017 happening twice in a row.

Pay off the debt. Use the freed up cash flow to pay down your loans.
Last edited by aristotelian on Thu Mar 08, 2018 3:54 pm, edited 1 time in total.

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Alexa9
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Re: Does it ever make sense to withdraw Roth IRA contributions to reduce credit card debt?

Post by Alexa9 » Thu Mar 08, 2018 3:54 pm

You can't get Roth contributions back. I would do this as a last resort. Think about how much they will be worth in retirement. Balance transfer, cutting expenses for a while, asking family for a loan, etc. would be preferable.

observata
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Re: Does it ever make sense to withdraw Roth IRA contributions to reduce credit card debt?

Post by observata » Thu Mar 08, 2018 4:02 pm

aristotelian wrote:
Thu Mar 08, 2018 3:54 pm
Pay off the debt. If you leave the funds in Roth, you have average expected return of 10% with a lot of risk and fluctuation, combined with a guaranteed drag of -20%. Generally you will be losing money to the debt. I would rather pay off the debt and have 0 invested with 0 debt.

To put it in perspective, last year was I am guessing in the top quartile of annual total returns for stocks, maybe even better than that, and you would have barely broken even by staying in Roth. I would not bet on a year like 2017 happening twice in a row.

Pay off the debt. Use the freed up cash flow to pay down your loans.
Thank you, this is helpful analysis.

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Meg77
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Re: Does it ever make sense to withdraw Roth IRA contributions to reduce credit card debt?

Post by Meg77 » Thu Mar 08, 2018 4:12 pm

observata wrote:
Thu Mar 08, 2018 3:11 pm
I'm trying to understand and reconcile (or prioritize) two conflicting pieces of advice, and I'm wondering if someone better at math can help me think it through.

- Principle #1: Pay off high-interest debt before saving or investing at a lower interest rate.
- Principle #2: Avoid withdrawing from retirement accounts to pay down debt.

These seem irreconcilable. Under Principle #1, if I have $5k in available cash, I should use it to pay down credit card debt (APRs ranging from 14-24%). Under Principle #2, if I already put that $5k in a Roth yesterday, I should just leave it there.

In the context of Roth contributions (which can be withdrawn penalty-free), the act of contributing $5k today and the act of not-withdrawing $5k today seem identical. So Principle #2 would suggest not only leaving the current contributions alone, but also putting the $5k cash into the Roth before the April deadline for 2017 contributions and deferring some debt payments until later.

Please include some explanation and analysis (or links to relevant reading) rather than just bottom-line opinions. I have read many books on personal finance and am trying to develop a deeper understanding of the mechanics—no self-help pointers or sermons, please.
Principal 2 of not withdrawing from retirement accounts to pay down debt was primarily established regarding cashing out or borrowing from a 401k or Traditional IRA. Fewer people have very much in Roth accounts historically speaking, especially since Roth 401ks weren't really much of a thing until recently. Of course cashing out Traditional retirement accounts is generally not recommended due to tax and penalty considerations.

However, cashing out any investment or retirement account is seen as cheating to some degree because it doesn't break the habit or behavior that led to the debt accumulation in the first place (to the extent that overspending is/was a problem rather than getting a degree or a medical event that led to massive medical bills). Taking the easy route of cashing out investments to pay off debt is seen as an easy short cut that will likely lead to the same behavior continuing - i.e. overspending - and more debt accumulating eventually. Meaning you didn't actually get rid of the debt problem, but you cashed out your retirement and lost out on the decades of compounding returns as a result.
observata wrote:
Thu Mar 08, 2018 3:11 pm
In case it matters, I am in my early 30s, recently started having a high income (> $200k per year before taxes), and have $72k in traditional and Roth IRAs ($16k in the Roth). But I also have very high debt, including about $65k in credit-card debt and > $330k in federal student loans. So I have both oversaved and overspent in the past. l now earn roughly $3k-4k per month that I can use to pay down debt or invest.
This is great news about your income. You owe 2 years worth of earnings on consumer debt which is certainly a challenge, but at least you have a great income to go with it. If you can throw $50k a year at the debt, which you say you can, you will be debt free in just over 4 years depending on the interest rates. Cashing out your Roth Contributions (remember you can't cash out the earnings) would only make a small dent anyway. On the flip side, putting $5500 in a Roth each year wouldn't slow your progress materially either.
observata wrote:
Thu Mar 08, 2018 3:11 pm
Other potentially relevant considerations:

- My credit score sucks because of the amount of debt and the debt-utilization ratio, but I have never missed a payment. Well you don't need to borrow more soon anyway, so this doesn't matter much. It'll improve as the cards get paid down too.
- Because of my recent income increase, 2017 is likely the last year that I can make Roth contributions without rollovers (does that matter?). Once contributions are withdrawn or a given year's contribution period expires, that opportunity is permanently lost. It does matter if you can't contribute directly in your case because you have substantial T-IRA balances. That means doing a backdoor Roth IRA contribution isn't really viable for you for tax reasons. Can you roll your T-IRA(s) into a workplace 401k plan? If so, then you can make backdoor Roth contributions indefinitely tax free.
- The Roth contributions could conceivably serve as a true "emergency fund"; on the other hand, (1) improving my credit score and getting access to credit at reasonable rates again could serve the same function, and (2) that high-interest credit card debt is itself an "emergency" and would make any other emergency unmanageable.You do need some amount of cash in savings to avoid being "forced" to take on more debt when/if a true emergency arises. And yes, cash in a Roth IRA can serve that purpose. But access to credit isn't the same as savings - those kinds of thought patterns will keep you in debt making payments for life. You have a high income though; you should be able to cash flow any "emergency" besides a layoff. Paying down your revolving debt balances is the quickest route to a better score anyway.
- The credit card debt is creating a lot of stress for me. For example, it makes me feel that losing my job would be a financial catastrophe.Yes, it would be. Sorry but it's true. Hit the credit cards hard with the $4k per month you have available, and they should be gone in a year (depending on how much of the current payments is going to principal and what the rates are). You can do this! Just keep living like you didn't get that raise for a bit.
- Since I have so much higher-interest debt, my student loans have long been in forbearance and I am putting off making any payments (but the interest is not capitalizing). On a standard student loan repayment plan, my monthly payment would be over $3,700 per month.So the balances are not growing? This is dangerous, though I would tackle the credit cards first if possible anyway. With your income you may have a professional degree. If so you might consider a refinance of the student loans with sofi or drbank to get a much lower rate. You'll have to start making payments of course though.

I appreciate your thoughts. I would especially appreciate an answer that would help me make a spreadsheet or otherwise improve my understanding.
The snowball method is probably your best bet unless some of your debts are super high like over 15% interest. With your low score that may be the case. I'd sort your debts from smallest balance to largest balance, and tackle the smallest balances first. Knocking the little ones out quickly is motivating and builds momentum. Studies show people get out of debt faster and pay off more debt this way versus tackling the largest interest rate first. However if some that are close to each other in balance are way different in interest rates, prioritize the higher rates if you are looking at cards over 10-15% or so. But if that is the case then you for SURE shouldn't be considering putting money in a Roth IRA over paying those down.

Good luck!
"An investment in knowledge pays the best interest." - Benjamin Franklin

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Smorgasbord
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Re: Does it ever make sense to withdraw Roth IRA contributions to reduce credit card debt?

Post by Smorgasbord » Thu Mar 08, 2018 4:19 pm

Today:
observata wrote:
Thu Mar 08, 2018 3:11 pm
In case it matters, I am in my early 30s, recently started having a high income (> $200k per year before taxes), and have $72k in traditional and Roth IRAs ($16k in the Roth). But I also have very high debt, including about $65k in credit-card debt and > $330k in federal student loans.
From 2015:
observata wrote:
Wed Jun 03, 2015 2:44 pm
This is my first post. The good news: I'm under 30 with an income of ~$60k that will rise significantly in a few months and should average around ~$200k before taxes in the next few years. The bad news: I have about ~$40k in non-student debt (interest rates ranging from 0%-deferred to 9%) and ~$300k in federal student loan debt (interest rate 6.5%).
It seems like you are trying to be too clever by half with your finances, and it has not gone well.

observata
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Re: Does it ever make sense to withdraw Roth IRA contributions to reduce credit card debt?

Post by observata » Thu Mar 08, 2018 4:22 pm

Meg77 wrote:
Thu Mar 08, 2018 4:12 pm
observata wrote:
Thu Mar 08, 2018 3:11 pm
I'm trying to understand and reconcile (or prioritize) two conflicting pieces of advice, and I'm wondering if someone better at math can help me think it through.

- Principle #1: Pay off high-interest debt before saving or investing at a lower interest rate.
- Principle #2: Avoid withdrawing from retirement accounts to pay down debt.
Principal 2 of not withdrawing from retirement accounts to pay down debt was primarily established regarding cashing out or borrowing from a 401k or Traditional IRA. Fewer people have very much in Roth accounts historically speaking, especially since Roth 401ks weren't really much of a thing until recently. Of course cashing out Traditional retirement accounts is generally not recommended due to tax and penalty considerations.
Good point, thanks for the thoughtful response.

GoodJanet
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Re: Does it ever make sense to withdraw Roth IRA contributions to reduce credit card debt?

Post by GoodJanet » Thu Mar 08, 2018 4:23 pm

I don't think you have oversaved for retirement. You are in your early 30s and have "$72k in traditional and Roth IRAs ($16k in the Roth)."

I know that the credit card debt is weighing on you. But at the same time, you now have a big shovel (the $3-4K/mo you mentioned) to dig yourself out of debt.

I would take the previous posters' advice to check out Dave Ramsey (you can get the Total Money makeover book from the library). Make a complete budget, go line by line reducing spending wherever you can. Be ruthless (get a roommate, make all meals at home, cut the gym or any expensive treats, find cheap or free alternatives to things). Take that money and save a month's worth of expenses as an emergency fund (that will help mitigate against the feeling "that losing my job would be a financial catastrophe"). And stop using the credit cards.

Once you have that emergency fund, pay off the most expensive debt first (the highest interest rate) or, if you go by the Dave Ramsey method, the smallest debt (for the quick psychological win). Either way, set goals for yourself for getting rid of the credit card debt. Once you get to the student loans, I'd shift to saving for retirement in a pre-tax account while also paying off the >4% student loans, greatest interest rates first.

It sounds like you don't have any dependents so it should not be hard to continue living like a student for a bit. It's not forever.

Good luck. You will be fine.

chevca
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Re: Does it ever make sense to withdraw Roth IRA contributions to reduce credit card debt?

Post by chevca » Thu Mar 08, 2018 4:44 pm

The way I see it, it matters little for the OP which route they choose. I would call $65k in CC debt an emergency for sure. But, taking $16k from the Roth doesn't take all that big a chunk out of it. At least, not when 4 months of so of extra money going that way would be about the same. It doesn't give you much of a head start, rather than just attacking with extra cash each month.

Or, leave it in the Roth. I'm not all that familiar with the backdoor Roth process, but I think the $72k in your Traditional IRA messes that up for you. So, your Roth may not be all that easy to keep contributing to and may stay smallish.

Either way, once you get all the debt paid off and have an even higher savings rate, your taxable account will likely dwarf all the others in short time.

So, do whatever feels best with the Roth money is probably the easiest answer.

MathWizard
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Re: Does it ever make sense to withdraw Roth IRA contributions to reduce credit card debt?

Post by MathWizard » Thu Mar 08, 2018 4:54 pm

Unless you are paying a default rate (something like 32%) leave the ROTH intact, and use it as an EF.

Reasoning:
You won't be able to contribute directly to a ROTH after this year (though you could possibly use a backdoor
ROTH, but that door could close in the future).

Put the $3-4 K/month extra towards the CC's to kill the $65K in CC debt (automate it if you can to keep it out of your hands).
In 2 yrs. you will have eliminated this debt.

JBTX
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Re: Does it ever make sense to withdraw Roth IRA contributions to reduce credit card debt?

Post by JBTX » Thu Mar 08, 2018 4:59 pm

What to do depends on different factors.

If the choice was either payoff credit card, or invest in Roth and keep credit card debt long term, the answer is pay off the high rate debt.

If the choice is payoff credit card debt this year, or invest in Roth and pay off credit card next year assuming funds will definitely become available, investing in Roth may be best, because you will get decades of tax free growth.

If the answer is somewhere between there, it is a judgement call. I tend to favor paying off the high rate debt, because if you don’t otherwise have funds to pay it now, and there is a history of running up credit card debt, the risk is high that next year you won’t pay the cc debt as planned.

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dratkinson
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Re: Does it ever make sense to withdraw Roth IRA contributions to reduce credit card debt?

Post by dratkinson » Thu Mar 08, 2018 5:28 pm

Note. If you don't fix your spending problems, you will save nothing for retirement. The existence of your Roth is tempting you into believing it is a partial problem solution. It is not, but it could become another victim of your spending problems. Don't let that happen. Don't drain your Roth. Save it to be used as an emergency fund in a doomsday scenario; or to pay for your retirement.


Assume $5.5K in a Roth, 7% return, 30-years to retirement. That money will grow to ~$40K if you leave it invested; $0 if you withdraw it, which will annoy your retired self. You've already paid the tax to get money into a Roth vs. into a traditional IRA.

Your real problem is the spending habits which allowed you to amass the CC debt. Without fixing the spending problem, then planning to withdraw from a retirement account is no fix... it just drains your retirement account. It's best to protect your retirement account from your bad habits.

--Leave your Roth intact. But hold off on making new contributions until you've fixed the spending problems and paid off your debts.
--Fix your spending problems.
--Pay off your debts.
--Resume saving for retirement.


Congratulations on your recent pay increase. Every cent goes toward paying off your debts.


Can search forum for others who have paid of debts and gotten their financial life back on track. You are not alone in this. It can be done.
See: http://www.google.com/search?q=paid+off ... rg%2Fforum


It's cheaper to avoid a problem, then it is to fix a problem.

--Common financial mistakes. I found the book, The Only Investment Guide You’ll Every Need by Andrew Tobias, to be most helpful in avoiding many personal-finance mistakes. I've read others recommending How to Make the Most of Your Money by Jane Bryant Quinn.

--Exotic financial mistakes. The White Coat Investor's "Stupid Doctor Tricks" is interesting.
See: https://www.whitecoatinvestor.com/stupi ... -mistakes/


When your income is too high to contribute to a Roth, then you can use the "backdoor Roth" concept.
d.r.a, not dr.a. | I'm a novice investor, you are forewarned.

ionball
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Re: Does it ever make sense to withdraw Roth IRA contributions to reduce credit card debt?

Post by ionball » Thu Mar 08, 2018 5:58 pm

I think of a Roth-IRA as a limited resource that will give you tremendous flexibility when you are age 71 and older. Protect it if you can. Only use it before age 71 as a last resort in the case of complete desperation. Attacking debt can be difficult and usually requires disciplined patience. Developing those traits can lead you to financial freedom!

michaeljc70
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Re: Does it ever make sense to withdraw Roth IRA contributions to reduce credit card debt?

Post by michaeljc70 » Thu Mar 08, 2018 7:50 pm

Watty wrote:
Thu Mar 08, 2018 3:50 pm
observata wrote:
Thu Mar 08, 2018 3:11 pm
I am in my early 30s, recently started having a high income (> $200k per year before taxes)
......
l now earn roughly $3k-4k per month that I can use to pay down debt or invest.
You are asking the wrong question. The problem is not how to juggle money it is how to spend less so that you have more disposable income.

A few years ago your income was a lot lower and you lived OK(except for running up credit card debt) when you were living on a lot less. For example if you were living on $60K a year a few years ago then you now have an extra $140K in income. A lot will go to taxes but if you pretty much lived like a student for a bit longer you could have the credit cards paid off well before the end of the year.

You might want to post the details of your monthly budget and where all the money is going so see if you can get some suggestions on where you might be able to free up more money.
This is what came to mind to me as well. Making over $200k and can only spend $40k or so toward debt? Maybe in a HCOL area?

That being said, I would probably not take the money out of the retirement funds and pay the penalty. Even if you take it all out, it will still only barely make a dent in the debt. And if you lose your job and have no savings, that would be bad (I am assuming you have no emergency fund).

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