Can You Borrow from Your 401(k) to Avoid Filing for Bankruptcy?

The money held in your 401(k) is yours to withdraw, provided you are fine with incurring a tax on withdrawn funds if you have not yet reached retirement age. That doesn’t mean that debtors should borrow funds from a 401(k) to pay off debts in an attempt to avoid bankruptcy.

You can withdraw funds from your 401(k) to avoid filing for bankruptcy if you want to. However, those withdrawn funds might incur a 10% tax, impacting your retirement account more than you might have anticipated. If you instead file for Chapter 7 bankruptcy, you can protect your 401(k) by claiming federal or state exemptions. While Chapter 13 bankruptcy requires repayment over several years, debtors shouldn’t have to borrow from a 401(k) to meet payments as they are determined by a debtor’s income, not retirement assets.

To schedule a free and confidential case evaluation with Young, Marr, Mallis & Associates, call our Pennsylvania bankruptcy lawyers today at (609) 755-3115 or (215) 701-6519.

Can I Borrow Money from My 401(k) to Avoid Filing for Bankruptcy?

If you are dealing with overwhelming debt and do not have a sufficient income to meet payments on time, leading to more debt, know that turning to your 401(k) is unnecessary. While debtors can borrow from a 401(k) to avoid filing for bankruptcy, doing so is typically not a good idea.

The most amount of money many people have at any given time is held in their 401(k) plans or other retirement accounts. These accounts are meant to fund your future as you age, not to support you financially before retirement. Because of this, borrowing money from a 401(k) before a person has reached a certain age will likely come with taxes.

People who withdraw funds from a 401(k) before they reach age 59 and a half will incur 10% tax on withdrawn funds. This is because any money borrowed from this type of account before retirement is considered an unqualified withdrawal. So, to borrow money that will address debt if you are under the age threshold, you will have to withdraw more money than you actually need to account for the 10% tax. This might ultimately deplete your retirement account.

That said, borrowing from your 401(k) might seem like the only option if you do not have disposable income to put toward paying off debt. To make it so that you do not have to borrow from your 401(k), our West Chester, PA bankruptcy lawyers can assess your finances to determine whether bankruptcy might suit you. Upon looking at your financial situation, it might become clear that either Chapter 7 or Chapter 13 bankruptcy meets your needs and can help you manage your debt in a timely fashion.

Will I Have to Borrow Money from My 401(k) to Make Payments While in Bankruptcy?

While one type of bankruptcy, Chapter 7, satisfies debt via asset liquidation, another, Chapter 13, gets the same result through repayment plans. This method allows debtors to address debts via consolidated payments at lower interest rates. If your income is tight yet you still qualify for Chapter 13, you shouldn’t have to borrow from your 401(k) to meet scheduled payments.

Debtors that file for Chapter 7 bankruptcy won’t have to worry about borrowing from a 401(k). Instead, they will repay creditors by liquidating their assets, and retirement accounts are typically protected from liquidation.

Chapter 13 bankruptcy is a different story. While you won’t have to liquidate your assets to pay back creditors, you will have to repay them using a repayment plan. To qualify for this type of bankruptcy, your income has to pass a means test. Income doesn’t include 401(k) plans, so the money in your retirement account won’t be considered when determining the amounts of your monthly payments.

That said, things can change during the three to five years you are under Chapter 13 bankruptcy. You might lose your job or have a change in income that alters your ability to make scheduled payments. Instead of borrowing from your 401(k) in this instance, our attorneys can take a second look at your repayment plan and adjust it so that you can make payments according to your new income. Do not assume that you should have to borrow from your 401(k) at any point during bankruptcy, as you may be able to safeguard those funds.

Can I Protect My 401(k) if I File for Bankruptcy?

While many people view bankruptcy as a scary thing that should be avoided at all costs, it can be used to help debtors protect certain assets, like 401(k) plans, from creditors seeking repayment. Filing for bankruptcy can allow you to settle your financial difficulties now so that you don’t have to deal with them later.

When you file for bankruptcy, you can take intentional steps to protect your 401(k). Our attorneys can help you claim exemptions if you file for Chapter 7 so that your 401(k) is not vulnerable to liquidation. While 401(k) plans are generally protected from seizure from certain creditors, other retirement accounts may not be given the same protections. In fact, IRAs and Roth IRAs are typically only protected from seizure when debtors file for bankruptcy.

Risking the safety of your 401(k) because you want to avoid filing for bankruptcy might result in you borrowing from your account at high rates, ultimately leading to an unsatisfactory outcome. Filing for bankruptcy provides you with the time and resources to make a plan moving forward that addresses your financial situation in its entirety so that you do not have to borrow from your 401(k) or jeopardize its ability to support you financially into your retirement.

Speak with Our Lawyers Today About Filing for Bankruptcy

For a free and confidential case evaluation with Young, Marr, Mallis & Associates, call our Philadelphia bankruptcy lawyers today at (609) 755-3115 or (215) 701-6519.

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