Should I Take Money Out of My 401K to Pay Off Debts?

March 20, 2015

Your retirement fund, also known as 401K, is something that you work your entire life for. The last thing you want is for bankruptcy to swipe all of your retirement savings out from underneath you. Luckily, under state and federal law, your 401K plan is considered “exempt” or a protected asset in bankruptcy. No creditor can legally touch any funds in your 401K.

However, under no circumstances should you ever take money out of your 401K to pay off debts or use as cash to cover everyday expenses. Money that you pull out of your 401K is not protected if you file for bankruptcy and it will eventually have to be paid back into your retirement plan or it will be taxed. Therefore, your bankruptcy trustee will treat the money that you loaned from your 401K as a debt obligation.

In addition, money withdrawn from your 401k or other retirement account will count as additional income for income tax purposes as well as income to determine your eligibility for filing bankruptcy.  If you withdraw from your 401k within six months from filing bankruptcy, the withdrawal will be used in the calculation for means tests purposes.  Prior to touching your retirement, consult with your attorney or account to make sure you understand the potential ramifications.   

Be very careful if you are considering taking any money out of 401K. Not only may hinder your bankruptcy case, but it can also affect your taxes. If you take funds out of your 401K then you will be taxed on the amount at a higher rate, and if you take a loan from your 401K, then you will be charged interest that is going back into your retirement account (so you are essentially paying yourself back). If you need to retrieve access into your 401K balance early, then you are probably in a jeopardizing financial situation and will most likely not have the means to reimburse your 401K at a later date. 

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