As a bankruptcy attorney, I meet with people on a daily basis to assist them with debt issues. Sometimes I advise them to file a Chapter 7 or 13 bankruptcy. Sometimes I talk to them about decreasing expenses or increasing income. One thing I have never told anyone to do is to take a distribution from a 401k to pay off their debt, so I wanted to take this opportunity to blog about why I don’t advise clients to use retirement funds to avoid bankruptcy.
Lets start with a story about a couple. The couple could live in Westfield, Indiana, Fishers, Indiana, or anywhere else on the North side of Indianapolis. The couple has 2 children and both work outside the home. Combined, the couple was making $135,000.00 last year. However, due to a change in jobs, the couple will make $100,000.00 this year. They are having a hard time adjusting their budget to their new, decreased income. As a result, they have incurred a significant amount of credit card debt and owe about $50,000.00 to various credit card companies. Their house payment, car payment and credit card payments are all current. However, they know it is only a matter of time before they aren’t able to pay all of their bills.
I know some people reading this are thinking that a family of 4 should have no trouble making ends meet while making $100,000 per year. However, it can be difficult to adjust to a new, lower income and when debt payments are taking a large majority of your take-home income every month it can be very difficult. I know this because I meet with a lot of families who earn good incomes at my Carmel, Indiana office. While debt problems are certainly more easily overcome without bankruptcy when a family makes a good income, it is not always possible. It really depends on the amount of debt.
But, getting back to our fictitious couple…..often the couple would contact Halcomb Singler, LLP, for a consultation and tell me that they planned on taking a 401k distribution or 401(k) loan and that they were going to completely pay off their debt to avoid bankruptcy and get back on track. This is certainly an option. However, I have never advised a client to take a loan or distribution from a 401k to pay off debt.
In this scenario I would continue to advise against using a 401k to pay off debt. The first reason is that in Indiana your 401k retirement account is completely protected from creditors. That means that whether or not you file bankruptcy, no creditor can get to your 401k. If you file bankruptcy, the trustee cannot take your 401k so long as you have properly exempted it in your petition. Secondly, although no one likes to think about it, you are going to grow old some day. You are going to need the money that you are saving for retirement. You don’t want to be the person relying solely on social security to get you through the month and no one is going to give you a loan for living expenses in retirement. Right now you have years before retirement to allow that money to grow. If you take it out now and spend it to pay your creditors then you will be starting all over, or at least setting yourself back several years. Finally, in this situation, the couple needs to get a handle on their new budget. If they don’t do this then they will be right back in the same situation within a couple of years. They need to sit down and develop a new budget that their family can stick to without the help of credit cards. One of the worst things I see in my bankruptcy practice is for a client to come see me after they cashed in a 401k and then they still need to file bankruptcy a year or less later. It is essential that the couple get to the cause of the issue, which is failure to adjust to their new budget by cutting some expenses or by increasing their income in order to balance their budget.
If you are thinking about raiding your retirement to pay off debt in lieu of filing a bankruptcy, please consult with a bankruptcy attorney. Most attorneys, including Halcomb Singler, LLP, give a free initial consultation regarding bankruptcy. Take that opportunity to ask questions and get advice. If you live in the Indianapolis area and would like to meet at my Carmel office call us at (317) 575-8222 or click here.
**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.