When someone is in debt, they are starved for cash. One source of potential cash is your 401(k) or IRA account. You might think that tapping your 401(k) or taking out a 401(k) loan is a good idea, but it’s not.
Your 401(k) is a Bankruptcy Safe Asset
Your 401(k) is totally exempt in bankruptcy. This means that no matter how much you have in your 401(k), you get to keep the whole thing. This means that if you use your 401(k) to pay back debts, then you are actually losing money. A bankruptcy will eliminate your debt and let you keep your 401(k). Your 401(k) is probably one of your most valuable assets. Even if it has gone down in value because of the stock market crash in 2007-2008, it will most likely regain it’s value over the next few years. Your goal is to exit bankruptcy with no debt and as many assets as possible. If you are faced with debts and you have a 401(k) or IRA, your best bet is to file bankruptcy, eliminate your debts, and keep your retirement accounts.
Withdrawals From Your 401(k) or your IRA Account Count as Income
When you file bankruptcy, one of your goals is to have the lowest possible means test result. One of the ways to do this is to minimize your income as much as possible. If you have made a withdrawal from your 401(k) or IRA in the six months prior to filing bankruptcy, then that withdrawal will increase your overall income on the means test.
If you have made a withdrawal from your 401(k) or IRA and still need to file bankruptcy, your bankruptcy lawyer can help your minimize the impact of that withdrawal.
401(k) Loans Cost Cost You a Double Interest Rate
When you take out a 401(k) loan, you pay interest on the loan, but you also lose the earning power of that money in your 401(k) account. This is because the more money that you have in your 401(k) the greater your earnings over time. When you take money out of your 401(k), you are losing the earning potential for that money. Combine the lost earning power of that money with the interest on the loan, and you are losing twice. It is more cost effective to keep money in your 401(k).
401(k) Loans Are Not Part of Your Bankruptcy
A 401(k) loan is not subject to the automatic stay and are not dischargeable in bankruptcy. This means that when you file bankruptcy, you have to keep making the 401(k) loan payments.
What To Do
If you have withdrawn money from your 401(k) or taken out a 401(k) loan, then all is not lost. Your bankruptcy lawyer can help you structure your debts and time your bankruptcy filing so that you avoid or mitigate the negative effects of making a withdrawal or borrowing from your 401(k).
Contact the Law Office of David H. Fuller, a Seattle bankruptcy attorney, for your free consultation.
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