I am not sure that anything is more frustrating to a bankruptcy attorney than when a client who is preparing to file bankruptcy has recently taken a 401k distribution. Not only is the client going to pay income tax on that money, but they may also have paid a penalty to access that money. But the worst part is that taking out money from their 401k did not help them avoid bankruptcy, and the money would have been protected from their creditors if it had been left in the 401k. Finally, the client is often approaching retirement age and may have just taken out the majority of what they had saved for retirement.
A while back I wrote a blog about Indiana Bankruptcy Exemptions. In this blog I explained that retirement accounts are normally exempt from both creditors and the bankruptcy trustee in a bankruptcy proceeding. This means that you can typically get through bankruptcy without losing any of the money in their 401k. So, prior to taking a 401k distribution you should consider the following:
1. Can you afford the income tax you will need to pay and potentially the penalty incurred with a 401k distribution?
2. What are you going to use the money for? Is it for a luxury, such as putting an addition on your home? In my opinion, 401k loans should not be used for any non-essential items. Is the money for your child's college tuition? I would also reconsider taking a 401k distribution for this purpose. Your child can get a student loan for school, but no one is going to give you a loan for your retirement.
3. Is the distribution an attempt to get yourself out of debt? Before taking a distribution for this purpose consider whether the money you receive (don't forget to deduct taxes and insurance) will be sufficient to actually get you out of debt. For example, think twice if your debt load will go from $40,000.00 to $20,000.00 after taking the 401k distribution. In addition, it is important that if your debt arose from bad spending habits or living outside of your means that you correct that behavior. If the root of the issue which caused you to incur debt isn't resolved you will find yourself back with just as much debt as prior to taking a 401k distribution.
4. How close are you to retirement? Do you have time to rebuild your savings for retirement? It is important to remember that many factors outside of our control can limit the number of years that we are able to work. You may not be able to work until you are 65, 67 or whenever you are planing on retiring. You don't want to look back on your decision 20 years down the road regretting that you tapped into your 401k.
The bottom line is that sometimes it is ok to take a 401k distribution to get you over a hurdle or beyond a pinch. However, a 401k should not be looked at as a savings account from which you can take distributions for an emergency. I have met with too many people who have taken a large 401k distribution only to find that they need to file bankruptcy only a few months more down the road. Having to advise a client that the 20k they took out 5 months ago in an effort to avoid bankruptcy could still be sitting in their retirement account and be exempt in bankruptcy is one of my least favorite things to do. If you are weighing whether you would be better served to try to settle your debts with a 401k distribution or file for bankruptcy and would like to meet with a qualified bankruptcy attorney you can contact me here or at my Carmel, Indiana office at 317-575-8222.
Halcomb Singler, LLP, is a debt relief agency. It helps people file for bankruptcy under the bankruptcy code. No attorney-client relationship with the firm of Halcomb Singler, LLP, is created through this blog. Also, please note that Erika Singler is an attorney licensed in Indiana and does not seek to practice law in any jurisdiction in which they are not properly authorized to do so. The information contained in this blog is general in nature and should not be relied upon for the circumstances of any individual(s) or businesses.
What about 401K contributions? Do they have to be stopped? I'm 54 and if I stop my contribution for the term of the Chapter 13, then I also loose my employer match which will make it very difficult to retire sometime between 67 and 70. We helped put 4 kids through college, so we didn't contribute during many of those years and as a result we are way behind on where we should be at this age.
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ReplyDeleteThe realisation of funds usually comes from two main sources: the bankrupt's assets and the bankrupt's wages. There are certain assets that are protected, referred to as "protected assets". These include household furniture and appliances, tools of the trade and vehicles up to a certain value. All other assets of value will be sold. If a house or car is above a certain value, the bankrupt can buy the interest back from the estate in order to keep the asset. If the bankrupt does not do this, the interest vests in the estate and the trustee is able to take possession of the asset and sell it.
Bankruptcy filing under Chapter 13 is more complicated. The process is longer, and there is a great deal of personal responsibility for debt relief. Experienced bankruptcy lawyer Theodore S. Collatos can guide you through this process will make your filing much easier to manage.
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