Don’t view retirement accounts as a way out of your financial problems

One of the top questions from people who are in debt is what will happen to their retirement funds if they file bankruptcy. Many people have heard that they lose many of their possessions during the process and assume that their retirement assets are one of them. Because of this belief, people feel justified in using their retirement assets to pay off debts, perhaps avoiding bankruptcy in the process. However, this is generally a foolish idea for a couple of reasons.

The first reason why people with financial problems should not take withdrawals from their retirement accounts is they will diminish their account, which has been established for retirement. Most retirement accounts financially penalize early withdrawals before retirement age. Additionally, early withdrawals will also be subject to income tax penalties. As a result, people who make withdrawals from their retirement accounts early find that they have to take out more money than they originally thought to cover their debts plus the penalties and taxes.

In addition to the immediate financial costs, early withdrawals hurt the account holder over the long run. Since the account holder will miss out on the compound growth that would accrue over time, early withdrawals may cause the holder to have insufficient assets for retirement once they reach retirement age, leaving them with little hope of replenishing what was lost in their advanced years.

The other primary reason why retirement assets should not be used to pay debts is that these accounts cannot be seized by creditors if one files for bankruptcy. Under the bankruptcy laws, most retirement accounts are exempt, meaning that the funds on deposit cannot be a source for creditors to satisfy outstanding debts. Under the laws, eligible accounts include:

  • IRAs (both Traditional and Roth)
  • 401(k)s and 403(b)s
  • Pensions
  • Keogh plans
  • Most defined benefit plans

Because retirement accounts are protected from creditors, those persons with financial problems can file bankruptcy without fear of losing what they have worked their whole live to accumulate. Once they have completed bankruptcy, filers can start over financially with their retirement assets untouched.

Although most retirement accounts are protected, the law takes a dim view of bankruptcy filers that attempt to defraud their creditors by transferring other assets into their retirement accounts just before filing bankruptcy. If the bankruptcy trustee discovers this type of wrongdoing, the filer could lose their exempt status on their retirement accounts, allowing creditors access to the funds inside them.

If in debt, seek legal advice

If you are suffering with financial problems that seem to have no end, the worst thing you can do is nothing. Doing so will almost certainly exacerbate your financial situation and limit your options. To learn about solutions that can get you out of your situation, contact an experienced bankruptcy attorney.