Is it a Bad Idea to Use my Retirement Funds to Pay Off Debts Prior to Filing Bankruptcy?


No one wants to be in a situation where they are living paycheck to paycheck.  Sadly, in today’s economy, it happens all too frequently.  Especially now due to COVID-19.  More often than not your paycheck may not cover all of your living expenses, so what do you do?  With the wide availability of credit cards and other sources of credit these days you may turn to credit as the solution to their problems.  Credit, however, is only a temporary band-aid for your problems.  What happens when the credit has reached the maximum limit and you can no longer borrow more funds?  You can also turn to your retirement account to pay off debts too.  This article will explain why that could be a bad idea.

You are planning and saving for your future when you invest in a retirement plan.  Ideally, these funds are to be used when you are retired.  ERISA (Employee Retirement Income Security Act) qualified pension and retirement plans such as 401(k)s, 403(b)s, profit-sharing plans, and Keoghs are exempted from the bankruptcy estate if you file for bankruptcy. The exemption is almost unlimited so it does not matter how much money you have in the retirement plan – you will not have to give up any of the funds if you file for bankruptcy.  If you have an IRA (traditional or ROTH), the limit is approximately $1 million.  That is still a pretty hefty amount that is safe from creditors.

When you make an early withdrawal from your retirement account you are hit with a tax penalty.  When you “borrow” funds from your retirement account you are creating a loan that normally accrues interest.  To make matters worse if you do not settle or pay off all of your debts what happens with the unpaid debts?  Unfortunately we meet with potential clients that have paid of one credit card only to have another sue them.  Paying off one card with retirement money in this situation is a complete waste of money.  If you only take out one of the eight lions chasing you what will save you from the other seven lions?  You will just have less retirement money and have achieved nothing unfortunately.  It is entirely understandable for everyone to want and try to stay out of bankruptcy.  There is no shame in that.  It would just be better to emerge from bankruptcy with as much money in a retirement account as legally possible.

When you file for bankruptcy protection all dischargeable unsecured debts will be wiped out upon completion of your bankruptcy case.    So why would it be a good idea to use exempt funds to pay off debts that would have been discharged in your bankruptcy case?  The answer – it isn’t.  However, most people use bankruptcy as a last resort, when all other solutions have failed.  By this time, your retirement funds are depleted, you have creditors hounding you for the unpaid balances and you still have no relief.

When you realize that you are unable to repay your debts it is a good idea to speak with an experienced bankruptcy attorney first to see what your options are.  Most bankruptcy lawyers like us will be able to quickly and accurately let you know what your options are.  It may be that bankruptcy is not right for you, but it should be ruled out first rather than borrowing from a retirement account. Bankruptcy may help you get a fresh start and debt relief AND help you keep your retirement funds for when you really need it – when you are retired and have no other source of income.