When trying to pay off debt, many people turn to their retirement savings. Some debtors cash out their 401(k) plans in an attempt to avoid bankruptcy. Of course bankruptcy is not something any debtor strives for. After all, bankruptcy can come with negative consequences. Thus, debtors usually want to pay off debts and are willing to employ any means necessary to do so. However, is it generally prudent to spend your hard earned savings trying to avoid bankruptcy?
If you spend your retirement savings on debts trying to avoid bankruptcy, you cannot get that money back. If, in the worst case scenario, you spend your retirement savings trying to avoid bankruptcy, but you are unsuccessful paying enough debt down, you will likely still have to file for Chapter 7 or Chapter 13 bankruptcy.
As a result, you will be in a worse position than you were when you started off. You will now have depleted your retirement savings and still have to deal with the adverse consequences of bankruptcy.
401(k) plans and other retirement savings are exempt from bankruptcy. If a debtor files for bankruptcy before withdrawing retirement funds, the retirement funds are safe from the bankruptcy filing. The debtor may have his or her debt discharged, and also maintain their retirement savings. The debtor will not have to cash the retirement savings out to pay off creditors.
As a result, it is wise to consider keeping your retirement savings, even in the event of financial difficulty. A Retirement savings is somewhat of a safety blanket since you always have the option of filing for bankruptcy while protecting certain assets like a 401(k) plan.
Every debtor should carefully consider the consequences of depleting retirement funds to pay off debts before making a decision. The decision will depend on the specific financial situation for each debtor; there is no blanket rule.
If the debtor’s reasonable living expenses surpass their future anticipated income, and the debtor does not plan on making more money or spending less money, the debtor probably should not deplete a retirement savings to avoid bankruptcy. With less money, there is little chance of ever paying off debt, thus bankruptcy may become necessary.