Staying Away From Your 401(k) in Bankruptcy

Published Sunday, November 29, 2009 @ 2:48 pm

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Americans young and old, hit hard by the recent economic meltdown, are turning to any available income, accounts, or other resources to pay down today’s mounting mortgage debt, crushing credit card rates and high health care costs. One such resource—liquidating a registered retirement account like a 401(k)—might appear to be a quick and easy fix to pay down looming expenses or even to avoid filing for bankruptcy.

In reality however, it’s better to “stay away” from 401(k)s, leaving these and other retirement accounts untouched and intact in times of financial distress—even for those bankruptcy bound.

Why, you ask?

Retirement Accounts Like Your 401(k) Are Exempt From Bankruptcy
First and foremost, it’s important to understand that your 401k is safe—even in bankruptcy. Assuming your registered retirement accounts, such as IRAs, 401(k)s, and pension plans, have not been used to secure loans, they’re considered protected assets. And recent amendments to the Bankruptcy Code have made these exemptions available in all states. In the alternative, cashing out a 401(k) automatically means losing your hard-earned savings, higher taxes, and potential delays in any bankruptcy filing.

Cashing Out a 401(k) Means Paying [More] Out In the Long Run
Using retirement savings to pay creditors can create new debt in the form of income taxes and early withdrawal penalties. In fact, considerably higher taxes are the norm if you cash in valuable retirement assets like your 401(k). This heavily taxed income also cannot be discharged in bankruptcy for years and may prevent other qualifying deductions. As a result, this expensive option creates even more economic troubles for families struggling with already weighty debts and considering the benefits of bankruptcy.

401(k) Liquidation May Provide a Substantial Burden to a Productive Bankruptcy
In terms of burdening your bankruptcy proceedings, liquidating your 401k to pay creditors could mean significant delays in productive bankruptcy results. Any cashed out 401(k) funds will be counted as income and considered when evaluating your economic status pending bankruptcy. Therefore, any withdrawals from 401(k)s should be disclosed to your bankruptcy attorney immediately.

401(k)s Fund Your Future
Just as bankruptcy provides a much-needed stopping point for those drowning in debt, maintaining registered retirement accounts, such as IRAs, 401(k)s, and pension plans—even in tough times—provides a comparable and essential starting point for your family’s viable financial future.

So, before you consider liquidating any retirement accounts, such as IRAs, 401(k)s, and pension plans, talk to the skilled bankruptcy attorneys at The Law Offices of John T. Orcutt.

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