Why you should leave your retirement accounts alone if you are in debt

If you are in debt, it is easy to get desperate and look to other sources you may have to pay off your debts. One source that some consider tapping is their retirement funds. Although paying back the debts you owe as soon as possible seems to be the most important thing at this moment, using your retirement assets to do so is a foolish idea in most cases. If you truly cannot pay back your debts using your non-retirement income and assets alone, bankruptcy would likely be a better solution with fewer negative repercussions.

One reason why it is not a good idea to use your retirement assets to pay your debts is that it will cost you additional money. As soon as you withdraw your money from your retirement accounts, you are hit with early withdrawal penalties and possibly tax liabilities. Because of this, you will likely have to withdraw more money than the amount of your debts, in order to ensure that the penalties are covered as well. Even if you manage to withdraw the money without penalty in the rare case, you lose the benefit of long-term compound growth of your money, which can significantly hurt you financially later in life.

Another reason why retirement accounts should not be touched to pay your debts is that these accounts are kept out of the reach of creditors during bankruptcy by law. As a result, creditors cannot force you to use the funds in these accounts to satisfy the debts they hold, if you file bankruptcy. Under the law, accounts that are exempt from your creditors include:

  • IRAs (Traditional and Roth up to $1,245,475)
  • 401(k)s and 403(b)s
  • Keogh plans
  • Pensions
  • Most other defined benefit plans

Although you may think that filing bankruptcy causes you to lose all your assets, in reality, retirement accounts are not affected by the bankruptcy process. Once you have completed bankruptcy, you are able to start over without many of your pre-bankruptcy debts, but are able to keep the retirement assets that you have worked hard to accumulate.

However, it is important for you to understand that you cannot use your retirement accounts as a way to defraud your creditors. Once you file either Chapter 7 or Chapter 13 bankruptcy, the court examines the transactions you made just before you filed bankruptcy. If it finds that you attempted to protect your non-retirement assets from creditors by transferring them into your retirement accounts, it can remove the exempt status from these accounts, allowing the funds contained within to be used to pay your debts.

Speak to an attorney

Since everybody does not always know about the exemption status of retirement accounts, many people needless sacrifice their futures in order to pay their debts that would have been eliminated in bankruptcy anyway. To learn more about the options available to you if you are in debt, contact the experienced bankruptcy attorneys at Prescott Pearson & Tande, PA Our attorneys can assess your financial situation and recommend the best way to obtain the fresh start you are looking for.