When money gets tight, there comes a time to pinch and squeeze in every area of your personal finances. You may need to dip into a savings account, take out a loan, or borrow money from a friend in order to make things work. You may have to cut out your daily coffee habit and restrict your nights out on the town. When you have to restructure your finances, it can mean making a lot of sacrifices. If things get really difficult, you may want to start pulling money from other accounts that you have, including your 401(k.) You may think that putting bread on the table is more important than saving for a comfortable retirement. Maybe the interest is piling up on your unpaid debts, and if you don’t start repaying the expenses you are worried that you are going to go underwater.
For some, dipping into a retirement fund may seem like the only way to reduce a debt. But you should research this choice before you make it. According to CNN Money, taking money out of your 401(k) to pay off debt comes with high penalty fees. As well, it will reduce the amount of money that you have available for retirement in the future. Walter Updegrave from Money Magazine says that as a general rule, you should steer clear of paying off a debt with retirement money. This is because that money is being stored away for a purpose. If you start using your 401(k) money for something else, then you are essentially defeating the purpose of the account. Some companies won’t even allow you to withdraw money from this account prematurely.
Most 401(k) plans won’t allow you to withdraw funds until you retire. Sometimes, if you leave for another job then you will have the right to access the finances inside. There are times that a company will allow you to access the account if there is a “hardship withdrawal.” This means that if the IRS determines that you have an immediate and desperate financial need this may be enough reason for you to cover the costs. If you are on the verge of foreclosure, but know that your 401(k) money could eliminate the debt, then you could possibly access the money for that reason. When determining whether or not you want to use the money in this account, you will want to talk with a financial advisor. If you are dealing with credit card debt, it may not qualify as an immediate and serious need. Therefore, you may not be able to access retirement funds to cover the costs.
Remember that even if you do withdraw money from the account, you will have to pay taxes on it. There is also the possibility of a 10 percent withdrawal penalty fee. Depending on how much money you are moving, the transfer can become very expensive. If you are dealing with consumer debt, then you may have another option. Sometimes you can borrow from a 401(k) and use the proceeds from the loan to pay off your debt. In this situation you are essentially borrowing money from your retired self that you will pay back later. Most companies will allow you to borrow up to 50 percent of your vested balance, or will cap the loan at $50,000. You can talk to your financial department for more information.
In a way, you will be trading your credit card debt for a 401(k) debt. This may be worth it because the interest is typically lower on a 401(k) loan than it is on a credit card. You will want to keep in mind that if you switch jobs or are laid off, you will probably be required to pay back the 401(k) loan within 60 to 90 days. If you fail to do this, you will have to pay heavy taxes on the loan as well as a potential 10 percent penalty. Some plans won’t even allow you to make contributions to your 401(k) while you have a loan outstanding. This means that you will slowly lose money on your retirement account and will not have nearly the finances that you would have in this account had you not taken out the loan.
If you are deep in debt and are worried that you will need to file for bankruptcy, you may be wondering what will happen to your 401(k.) According to the Employee Retirement Income Security Act, this account is protected under the United States Department of Labor if you file for bankruptcy. If you have a 401(k) loan to repay in a bankruptcy, it won’t be considered a real loan because you borrowed against yourself. This means that the debt can’t be forgiven in a Chapter 7 bankruptcy. In a Chapter 13, you will be able to structure the debt into your repayment plan.
If you are considering filing for a Chapter 7, you shouldn’t cash out your 401(k) beforehand. In fact, this action could actually disqualify you from being able to file for a Chapter 7. This is because if you cash out the account it will be counted as a part of your income. The best way to treat a 401(k) loan is to simply leave it alone. Because it is protected you can be sure that you will be able to keep this valuable asset in the event of a bankruptcy. Contact a bankruptcy attorney today if you need more information about 401(k) accounts and bankruptcy!