Divorce often forces tough financial decisions. For 40-year-old Mel, that decision boils down to whether to withdraw money from her retirement account or take on new debt to keep the family home.
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Mel needs a total of $90,000 to buy out her ex-husband’s share of their home. With $20,000 already in savings, she still needs to come up with $70,000. Her priorities are clear — she has a great mortgage rate and wants to keep the house to maintain stability for her children.
The question is, where should that $70,000 come from: her $100,000 401(k) balance or a loan?
Pros and cons of pulling from your retirement account
Most financial advisors will tell you that dipping into retirement accounts should always be a last resort. Those funds are meant to secure your future and pulling money out early can create major setbacks.
That said, in divorce cases like Mel’s, it may be worth making an exception.
The pros of pulling from retirement accounts in this situation include:
- No new monthly debt: Unlike a loan, pulling from retirement accounts avoids adding another bill to your plate during a stressful time.
- Immediate access to cash: The money is already there, so you won’t need to apply for a loan or pay interest rates.
- Protects good mortgage rates: Current mortgage interest rates are between 6-7%, so maintaining a lower rate can save thousands over the life of a mortgage.
- Possible exemption for divorce transfers: If the money is transferred from your retirement account to your ex’s retirement account, the funds can be transferred tax and penalty-free in most cases [2], reducing the cost of your premature withdrawal.
It’s worth noting that if the receiving spouse chooses to receive the funds in cash from there (rather than rolling it into another retirement account), they will be liable for any applicable state and federal taxes.
Read more: This is how much US drivers saved on car insurance when they switched providers, according to a new Consumer Reports survey of 140,000 policyholders
Of course, there are also cons to pulling from a retirement account to consider, including:
- Loss of compound growth: Removing $70,000 now could cost you hundreds of thousands in future growth [3]. For example, at a 7% annual growth rate, that $70,000 could add more than $379,000 to your retirement account by the age of 65.
- Weaker long-term security: Taking out these funds now reduces your retirement cushion and may force you to work longer to afford the retirement you want.
- Possible penalties: If the funds are pulled directly (meaning, into cash, rather than rolling over into your ex’s retirement account), you’ll usually have to pay a 10% penalty plus possible income tax [4]. And if this amount pushes you over into a higher tax bracket, then be prepared to pay more when it’s time to file.
If Mel ultimately decides to dip into her retirement account, clearly the best option would be to roll the $70,000 from her 401(k) into her ex’s retirement account. Doing so helps avoid income tax and early withdrawal penalties. However, Mel’s ex might not agree to this cushy arrangement. Moreover, even if he does agree, dipping into her retirement account to avoid financial hardship now may merely be deferring her problems to her retirement years.
Pros and cons of taking out a loan
Mel is worried about affording the cost of a personal loan, which is a valid concern. However, there are the following pros to consider:
- Preserves retirement savings: Her 401(k) stays intact, so she won’t have to play catch-up later. Similarly, Mel avoids all the costs with early withdrawals.
- Predictable repayment: Fixed interest rates and set monthly payments make it easier to budget, compared to a traditional home equity line of credit (HELOC), which often has a variable interest rate.
- No impact on the mortgage rate: Mel can keep her great mortgage rate without refinancing at a time when such rates are notably high.
Of course, there are also plenty of cons for such loans, including:
- High interest rates: Compared to other types of debt, personal loan rates can be high, depending on your credit. Looking at May 2025 FRED data, Mel could end up paying the average of 11.5% or even more depending on her credit score for just a 2-year loan [5]. And she would likely need more than 24 months to pay back $70,000.
- Credit requirements: Unlike a 401(k) loan, which borrows money that has already been saved, personal loans have income and credit score requirements.
- New monthly debt: A personal loan requires monthly payments, which may be challenging for her to manage, especially in the midst of a divorce when she may already be paying legal and other fees.
- No tax advantage: Unlike mortgage [6] or home equity interest, personal loan interest is generally never tax-deductible [7].
It’s not an easy choice to make, but understanding the pros and cons of each strategy is the first step to deciding what works best for her. Next, she may try to calculate projections for what each option might cost her over the next 5, 10, and 25 years, including the cost of lost compound interest versus the cost of higher interest for the HELOC.
Other ways to come up with the funds
Neither pulling from retirement nor taking out a loan is ideal. Fortunately, there may be other options to come up with the cash and protect Mel’s family home. Here are a few other methods to consider:
Payment plan with the ex
Instead of a lump sum, Mel could see if her ex would accept being paid the $70,000 in installments over time. This avoids debt or raiding retirement, though it does mean staying financially tied to her ex longer than she may prefer. And of course, he’d have to agree and accept his own costs associated with forgoing a lump sum upfront (which he may want to use for his future home himself).
Make other concessions in the divorce
Another option is to offer concessions elsewhere in the settlement. For example, Mel could let her ex keep other marital assets, such as savings accounts, vehicles, or rights to a pension, in exchange for the home. This balances the desire to keep the home with avoiding debt.
Negotiate the settlement
Depending on the terms of the divorce, you may be able to negotiate higher spousal support to account for increased mortgage costs — especially if Mel is responsible for the mortgage and the interest rate is higher following the separation and if she can prove that she is burdened by higher housing expenses due to a renewal or lack of guarantor [8].
Pull from a life insurance policy
Some permanent life insurance policies permit borrowing against the policy’s cash value. The loan usually isn’t taxed as income, though it does accrue interest and can reduce the policy’s payout if it isn’t repaid [9].
Split the difference
Mel doesn’t have to choose just one option. For example, she could withdraw part of the funds from retirement and cover the rest with a small personal loan. This limits both the retirement hit and the debt burden.
There’s no easy answer here. Pulling from retirement sacrifices long-term financial security, while borrowing creates an immediate monthly strain. The best option is ultimately highly dependent on many other details in this case, such as what her ex is willing to accept and forgo. If keeping the family home is truly the top priority, a retirement withdrawal handled through the divorce decree to minimize penalties may be less harmful than taking on high-interest debt.
However, before taking that step, make sure to exhaust all other options, including making additional concessions, setting up a payment plan, or borrowing from other assets, such as a life insurance policy.
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Article sources
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[1]. Ramsey Solutions. “Why You Shouldn’t Withdraw From Your Retirement to Pay Off Debt”
[2]. Merrill. “What happens to my retirement funds in a divorce?”
[3]. Investor.gov. “Compound interest calculator”
[4]. IRS. “Retirement topics – Exceptions to tax on early distributions”
[5]. Federal Reserve Bank of St. Louis. “Finance Rate on Personal Loans at Commercial Banks, 24 Month Loan”
[6]. IRS. “Publication 936 (2024), home mortgage interest deduction”
[7]. IRS. “Frequently asked questions”
[8]. FamilyLLB. “Can husband be forced to guarantee soon-to-be-ex-wife’s mortgage?”
[9]. Investopedia. “How Can I Borrow Money From My Life Insurance Policy?”
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.