In Bankruptcy Information, Bankruptcy Questions

When faced with seemingly overwhelming financial problems many people turn to loans from or cash outs of their retirement accounts. This is usually a bad idea for several reasons.

Your financial future is at stake.
First, taking from retirement is gambling with your financial security in retirement. Because the retirement accounts are invested in securities that are (hopefully) growing, removing funds from those accounts removes the base that grows. Unless that money is replaced quickly, over time the gap between what you have and what you would have had had you not cashed out the retirement account can grow to tens or even hundreds of thousands of dollars. Here’s an example. Suppose there is $100,000 in a 401(k), IRA or retirement account right now. Suppose further the owner needs $15,000 of that for bills, so he takes an early withdrawal. If he does nothing else and has 20 years until retirement, the balance of now $85,000 will grow to $225,530, assuming an average 5% annual return. If he had left that $15,000 in, he would have $265,329. The early withdrawal cost nearly $40,000 in retirement money. That’s $2,000 per year, which amounts to 13% interest on the $15,000 taken.

A loan from a retirement account is a little better, at least in theory, because the money is paid back over time. Still, there is that immediate gap between what is growing with and without the loan.

Doesn’t solve the problem.
Secondly, cashing out a retirement account to pay bills is often putting a band aid on a much larger problem. Unless the person addresses the underlying reasons for needing to access that money the likelihood is that she’ll be back in the same boat in a very short time. Only now the situation is worse because in addition to owing creditors she owes herself for the money she cashed out.

Exempt assets are non-exempt
Thirdly, by taking money from a retirement account, the person has converted exempt assets into non-exempt assets. Retirement accounts are exempt in bankruptcy, meaning the trustee can’t get at them. I once had a client who had over $800,000 in retirement accounts when he filed bankruptcy. The trustee didn’t even blink at the amount on the schedules because the trustee knew he couldn’t get at that money. Had my client removed that money, it would have become non-exempt. Suppose that during the time between the withdrawal and spending the money, it goes into a bank account and the account is garnished by a creditor. That money could all be taken by a third party and not used as it was intended.

Tax problems
Fourth, if you take an early withdrawal, you’re going to be hit with a hefty tax bill. Assuming the money was contributed to the retirement account as a tax deduction or before taxes, it counts as income when it comes out. In addition, there’s a penalty for early withdrawal. Enough said.

Before giving in to the temptation to access your retirement accounts to catch up on bills, make sure you understand the consequences of doing so. If you have financial problems and would like to explore your bankruptcy options, contact us here, or call or text (801) 413-3708, or email steve@schamberslaw.com.

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