Exemptions, 401k plans, IRAs and common liquidating mistakes by well meaning debtors.

Don’t use your retirement to pay creditors

Prologue: As a San Diego bankruptcy attorney, I hear the “should I use my retirement to pay creditors” question all the time. When contemplating this blog, I had thought to list the problem of paying creditors with retirement funds as one of my pet peeves. I decided that I would not classify this subject in that fashion, but I still mention it prominently here, since the issue troubles me greatly.

Blog: Time and time again, I will counsel with well meaning debtors who have taken the extraordinary step of liquidating a 401(k) or retirement account to try and maintain those minimum payments on the credit cards.

There are so many financial traps in this pursuit of keeping up.

Borrowing from family or friends is a classic. Reducing the withholding on the taxes per paycheck so that one can have more alleged ‘cash flow’. There are many others.

Why drawing down your 401(k) or IRA account to avoid bankruptcy is a bad idea

Today I will comment on the number one worst technique used by many debtors to try and stay afloat. That  is borrowing or drawing down on your retirement plan, 401k plan, pension plan, or IRA.

Should you do this, to maintain credit and stave off a potential bankruptcy? NO. ABSOLUTELY NOT! (Capital Bold Italic letters purposely typed for emphasis).

There are a number of strong reasons this tactic should be avoided at all costs, some are legal, some are more common sense:

• Many, if not all, 401k plans (if they are ERISA qualified) are excluded from a bankruptcy filing.
• Many, if not all, IRA’s are exempt from the property of the estate in a bankruptcy filing.
• Many, if not all, private and public pension plans are exempt from the property of the estate in a bankruptcy filing.
• There are significant tax consequences on liquidating a retirement plan, or borrowing against a plan, and failing to repay that debt.
• NO ONE ELSE IS SAVING FOR YOUR RETIREMENT, so, do not pay YOUR RETIREMENT to your creditors.

To be sure, there are variations in applicable law from state to state on the treatment or protection of a retirement plan in a bankruptcy. (This is another reason why it is extremely important to counsel with a competent bankruptcy attorney, so the maximum benefit and protections can be obtained). Still, even recognizing the type of retirement plan, and the specific state exemptions may vary, the base concept is sound.

Do not convert money that is likely protected under bankruptcy law into money that is not protected. Worse yet, do not hand over your retirement monies to your creditors in a vain attempt to avoid the filing of a bankruptcy. It may be a hard realization, but if one is considering or resorting to this tactic, a bankruptcy filing is likely inevitable. Please at least research the question with an attorney in your state, before liquidating your hard earned retirement savings.