01 Apr Credit cards or cash out IRAs after job loss

Q. I lost my job and I don’t have a big enough emergency fund. I’m afraid I will need to start using credit cards or take money from my investments. I have a Roth worth $18,000 and a regular IRA worth $38,000. What should I do?
— Jobless

A. We’re sorry to hear about your job.

You didn’t say your age or your marital status, so we’re going to assume you’re single and under 59½.

It puts you in a very tight bind.

The first recommendation is to slash your spending as much as you can, said Bernie Kiely, a certified financial planner with Kiely Capital Management in Morristown.

Let’s next look at your credit cards.

Kiely said the average credit card interest rate for people with fair credit is a whopping 21 percent, according to financial research firm CardHub. That works out to 1.75 percent per month!

“At that rate, a $1,000 balance would grow to $2,000 in 40 months, or three and a third years,” Kiely said. “That is a very expensive way to finance your living expenses.”

According to Credit Karma, the average minimum monthly payment on a credit card is 2 percent of the current balance.

That makes the minimum payment on that $1,000 balance is $20. Of that payment, $17.50 is for interest and only $2.50 is principal, Kiely said.

“After 120 months or 10 years, you would still owe $738.62,” he said. “Many people fall into credit card debt and are never able to get out.”

Looking at your Roth, there are some benefits.

Qualified distributions are not taxable if the following are true, Kiely said: You are 59½ years of age and it has been at least five years from the beginning of the year for which you first set up and contributed to a Roth IRA.

“Since I am assuming you are not 59½ your distribution is not a qualified distribution, you will have to pay some tax and a 10 percent penalty,” Kiely said.

Roth IRAs are funded with after-tax money, which means you have “basis” in your Roth IRA, Kiely said.

“The amount above your basis will be subject to ordinary federal and state income taxes,” he said. “In addition, because the distribution is not a qualified distribution it will be subject to an additional 10 percent penalty on the amount above your basis.”

Your traditional IRA is either a deductible and non-deductible IRA.

If put after-tax money into an IRA and did not get a tax deduction, you have basis in the IRA, Kiely said. If you made tax-deductible contributions to your IRA or rolled a 401(k) or 403(b) plan into your IRA, you have no basis in your IRA.

If you have basis in your IRA, you will have to pay taxes and a 10% penalty on the amount in excess of your “basis” that is withdrawn,” Kiely said. “Most IRA accounts have no basis and are 100 percent taxable plus there is the 10 penalty penalty on the full amount withdrawn.”

So what should you do?

Kiely said paying taxes is no fun but it is cheaper than paying 21 percent interest on a credit card balance.

He would suggest you fund your needs first with the Roth, than the traditional IRA, leaving credit cards as a last resort.

Good luck. We hope you can find a new job soon.

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This story was first posted in April 2016.