Your monthly bills are stacked on your kitchen table. The collection of letters and harassing calls is never-ending. You’re desperate to figure out how to get out of debt.
Then you remember that you have the money to pay off all (or some) of your debt in your retirement account. While it can be tempting to think, “I’ll just withdraw the money from my account and get out of debt now – I’ll have plenty of time to rebuild my retirement plan,” there are many factors you need to consider before doing this.
Reasons You Shouldn’t Cash Out Your Retirement Account
The short answer to if you should consider cashing out your retirement account is “No.” The long is answer is you should never use the retirement funds to pay debts without first consulting with a bankruptcy attorney.
Some reasons you should avoid this are:
Almost All Retirement Accounts Are Fully Protected in Bankruptcy
When considering filing for bankruptcy, you might think that you have to give up all of your property and assets – including all banking and retirement accounts. This is false. You are allowed to protect property through bankruptcy exemptions. This means that property marked exempt cannot be sold to pay debtors. Retirement accounts are assets that are almost always protected. Even accounts with over a million dollars can likely be protected.
Retirement accounts that qualify under the Employee Retirement Income Security Act (ERISA) – including 401(k) accounts – are even more protected. They are not even considered property of the bankruptcy estate, which means you don’t even need an exemption to retain them after your bankruptcy.
If you have a traditional or Roth IRA, it’s important to know that in these accounts, only a certain amount can be marked exempt — up to $1,512,350.
You Can Discharge Your Debts in Bankruptcy
If you are deep in debt, instead of blowing through your retirement account, you can file for bankruptcy. If you qualify for Chapter 7 bankruptcy (you will need to prove your income is below a certain threshold through a means test), most of your debts will be discharged. This can erase your debts and let you keep the balance in your retirement account. If you have a regular income coming in, you can pursue a Chapter 13 bankruptcy. Under this type of bankruptcy, you will create a court-approved repayment plan. This allows you to pay off your debt through a three to five-year plan. At the end of the plan, any remaining debts can be discharged. This can make your monthly payments more manageable, get you out of debt in a few years, and still let you keep your retirement account.
Withdrawing Funds Can Eliminate Your Protections
If you withdraw money from your retirement account and put it in a checking account to pay off your debt, you can lose the special protections reserved for retirement plans. This means that money may not be eligible for bankruptcy exemptions.
There Are Tax Implications
Cashing out your retirement plan can result in fees and taxes. If you are below retirement age, you will need to pay fees for taking the money out early. You will also have to pay taxes on the money you withdrew from your account. Even if you’re using the money to pay bills, it will be treated as additional income, and you will be taxed on it.
It Can Delay Your Retirement
Another item to consider before using your retirement account to pay off debt is that cashing it out can delay your retirement date. You will need to work longer to recover the money you spent on paying off your debt.
Consult A Bankruptcy Attorney Before Touching Your Retirement Account
Before cashing out your retirement account to pay off your debt, it’s essential to consult a bankruptcy attorney. Your lawyer will help explain the pros and cons of using your retirement funds to pay off debt, and ensure you understand the implications. Your attorney can also help you determine if filing for bankruptcy is a better option for you.
Let Us Help You
When you’re deep in debt and considering cashing out your retirement plan, let our lawyers at The Law Offices of Alexzander C.J. Adams, P.C. help you sort through your options and provide you with help and advice. We work for you, the people, and not institutions. Contact us for a free case evaluation, or no-obligation consultation. We are dedicated to helping you overcome this small bump in the road and assisting you to get on with your life.