Is It A Bad Idea To Borrow Against My 401(k) Or Pension Plan To Pay Debts?

On behalf of Bankruptcy Law Firm of Clare Casas on Wednesday, September 21, 2011.

Although many well-intentioned people borrow against their retirement accounts in order to pay off credit card debt, it’s actually one of the worse things you can do in the long run. Yes, it’s very tempting. Some pension plans have a hardship withdrawal provision. The money is just sitting there and the creditors are bugging you non-stop. You really meant to pay the money back anyway…you just lost a job or had an illness and plans changed. But think about it carefully as there are tax consequences, retirement consequences and bankruptcy consequences.

Tax consequneces: Retirement investments are given favored tax-treatment by the IRS while you are saving the money. Normally, you don’t pay taxes on money that you put in an IRA account or a company sponsored plan. If you cash out before you reach 59, you incur early withdrawal penalties and a tax penalty at the end of the year. You get back a lot less than what you put in and risk running up your tax bill.

Retirement consequences: I will never agree that it’s a good idea to wipe out your future income in order to pay creditors today. There will come a time when you cannot work. Social security is not so secure and doesn’t provide a lot of income anyway. You may not absolutely need that money today because you are working or still able to work – but there will come a time when you need it to survive. There are other things you can do to eliminate credit card debt other than eliminating your future income.

Bankruptcy consequences: Any withdrawal that you make from a 401(k) plan within the six months prior to filing a bankruptcy case is treated as income on the means test. In some cases, that is not a problem and you will still qualify for a Chapter 7 bankruptcy. In other cases, a withdrawal has put my client out of a Chapter 7 and into a Chapter 13 because they exceeded the median family income when I added in the withdrawal. Then the withdrawal gets counted as income for the purposes of determining your monthly payment to the court. Not a good idea.

If you are thinking of withdrawing money from a 401(k) to pay off credit card debt, pause first and schedule a free consultation in our Coral Springs or Davie office. Find out first if doing so will cause you unwanted consequences. Informed decisions are better decisions!