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Taking out a 401(k) loan to pay off debt

Currently, retirement accounts are many Americans' largest assets. That's why some people are turning to their retirement savings to pay down credit card debt that has spun out of control. However, according to financial experts interviewed by CNNMoney, this is a risky endeavor that often backfires.

Borrowing from a 401(k) account might seem like an attractive option to pay down debt because the loans are easy to qualify for and typically offer low interest rates. But there are several drawbacks, including losing out on the compound returns those funds would have accrued and paying taxes twice on the money borrowed.

For these reasons and others, a certified financial planner specializing in debt management who was interviewed by CNNMoney said he refers to the 401(k) loan as a "loan of last resort." In other words, instead of taking out a 401(k) loan to deal with debt, other options should be pursued.

One of these options could be bankruptcy. A Chapter 7 or a Chapter 13 bankruptcy may be the best way to deal with credit card debt or other unsecured debt such as medical bills that have become unmanageable. Both filing options provide individuals with a fresh start and can wipe most unsecured debt clean.

A major plus-side to bankruptcy is that retirement savings are protected from liquidation, so instead of putting your future at risk by borrowing retirement funds to pay off debts, your hard-earned retirement savings remain safe and sound for when you need them most.

Additionally, there are a few non-bankruptcy alternatives that should be considered to deal with debt. One is debt negotiation or debt settlement. This involves working out a lump sum settlement with creditors for less than the total debt owed.

For more information, consult a debt relief agency in your area.

Source: CNNMoney, "Should you raid your retirement savings to slash debt?" Melanie Hicken, July 12, 2014

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