Struggling financially Leave your retirement assets alone
When many people are suffering from debt problems, they look towards their other assets as a means of paying off their debts. One of the most significant sources of funds that many people have is their retirement account. Since they may not be using the funds at the moment, many people reason that it is okay to dip into the account to pay off what they owe. However, doing so is generally not a good idea for two reasons.
Reason one: financial penalties
Withdrawing retirement funds before retirement age is an expensive proposition, as doing so entails being charged early withdrawal penalties. Additionally, early withdrawals may also have income tax consequences. Because of this fact, many people that would like to pay their debts with their retirement funds find that they have to withdraw more money than originally anticipated to cover the taxes and penalties.
In addition, early withdrawals from retirement accounts are costly in the long run, as it causes the person to miss out on the interest and compound growth that would have occurred over the long term. Over time, even small withdrawals can make a big difference. Sometimes the difference is so great, it may force the account holder to delay retirement plans due to insufficient funds.
Reason two: retirement accounts are exempt
The other reason why retirement accounts should not be used to pay off debts is they are protected from creditors (or exempt) if bankruptcy is filed. As a result, if bankruptcy is filed to deal with the debt problem, creditors cannot use the retirement accounts as a source of funds to pay off what is owed. Most retirement accounts are eligible for this exemption, including: 401(k)s, pensions, Keogh plans, IRAs, 403(b)s and most types of defined benefit plans.
Since the retirement accounts are exempt from the reach of creditors, persons suffering financial problems can address their debts without raiding their life savings to do so. Once bankruptcy has been completed, the filer gets a fresh financial start with their retirement accounts untouched.
Of course, there are exceptions to this rule. The exemption may be lost if bankruptcy filers attempt to defraud their creditors by transferring money into their retirement accounts just before filing bankruptcy. In these cases, the court may order that the funds within be made available to creditors for outstanding debts.
An lawyer can tell you more
Although a powerful tool, bankruptcy is not something that should be rushed into. To find out if it is the best way to deal with your debt problem, speak with an experienced bankruptcy lawyer. An lawyer can assess your situation and advise you further on the most effective way to get you back on your feet.