If you fall on hard times, it may be tempting to use retirement accounts to pay off debts. Unfortunately, this is all too common, and usually a huge mistake.
Here’s the problem:
Many of those debts you paid could have been wiped out or substantially reduced in bankruptcy. At the same time, so long as your retirement funds are held in a qualified retirement account (such as an IRA, a pension, a 401K, or the government equivalent – a 457(b) or 403(b)), they are usually protected from the reach of creditors. This means you could discharge most, or all of your debt, while keeping all your retirement funds. There are few things more tragic than seeing a responsible individual liquidate a 401K account just to pay off a credit card balance. We know you want to be responsible, but let’s also be smart.
Anyone considering withdrawing retirement funds should seriously consider bankruptcy first. Retirement savings take a lifetime to accumulate, and should be preserved at any cost. A professional should be able to tell you whether you are about to make a huge mistake by withdrawing your retirement funds (hint: the answer is almost always, “yes”). And once that mistake has been made, you may never be able to rebuild that nestegg. Congress recognized that your retirement funds are something special. That’s why they drafted a Bankruptcy Code that preserves individuals’ retirement savings, even if they file bankruptcy. As the name implies, “retirement accounts” are intended to provide for exactly that: retirement. Anyone considering withdrawing retirement funds should first consider all other available options. As always, consulting with a professional is recommended.