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Ask a Bankruptcy Attorney: Is it Wise to Tap into Your 401k to Prevent Going into Bankruptcy?

When faced with mounting financial issues, people may rush to use all of their resources to make payments. It’s worth noting that this isn’t always the greatest choice. You should seriously think about all your choices, including bankruptcy, before using your retirement assets to pay off debts.

In many situations, filing for Chapter 13 bankruptcy might offer considerably greater long-term debt relief than taking cash out of or borrowing from your 401(k). Read on to learn more and then contact The Law Offices of Paul Y. Lee at 951-755-1000 for a free consultation with a bankruptcy attorney.

Problems with 401(k) loans

It might be quite tempting to think of your 401(k) as just another source of wealth that should always be at your disposal. However, your 401(k) is really only intended to be used for retirement savings, and the government has made some very good incentives for you to do so.

You may borrow money against your 401(k). It can make sense to take out a 401(k) loan to pay off a high-interest obligation if you can negotiate a low interest rate. However, you must ensure that the amount you would save on interest by paying off that loan more quickly justifies the risk of taking money out of your 401(k).

If you default on your 401(k) loan for whatever reason, you will be charged income tax on the loan amount and a 10% early distribution penalty if you are under the age of 59.5. If you’re not careful, these costs can cancel out the benefits of getting the loan in the first place.

Don’t just assume that you won’t experience this! You may be unable to return your 401(k) loan for a variety of reasons, some of which are beyond your control. For instance, it’s possible that your employer could go out of business or that you will need to resign your work on short notice and move closer to family. If this occurs, your loan will often become fully due within 60 days of your work ending, and it’s likely that you won’t have the money to pay it back.

Bankruptcy offers a different option

Many individuals fear debt so much that they would do anything to avoid it, even endanger their retirement. They are unaware that there are alternative debt relief options that would enable them to save their retirement resources.

The wage earner bankruptcy procedure, also known as Chapter 13, is an excellent illustration of a debt relief option other than selling retirement assets. Your obligations will be combined in this type of bankruptcy into a single, 3–5-year court-sponsored repayment plan. You won’t accrue any extra late fees or penalties during the process; the court will calculate your payment based on what you can afford.

The best part is that the vast majority of your assets will be shielded from the Chapter 13 bankruptcy process. This includes 401(k) and IRA exemptions totaling more than $1 million. Before you take that 401(k) loan, please get guidance from The Law Offices of Paul Y. Lee! We might be able to provide you with a better option.