Cashing in your retirement accounts to pay down debt is usually not a good idea. The tax consequences can be substantial and you probably have better options.
When your debt has become overwhelming, you may be looking for any way out that you can find. By and large, most Americans want to pay what they owe on their debts. People stretch themselves thin, juggling all the creditors and hoping that they catch a lucky break to change the situation. Sometimes it happens. Most of the time it doesn't.
Bankruptcy or debt settlement is rarely ever the first thing people consider. When the creditors start their calls and harassment, people sometimes get desperate to resolve their debt problems. They will sometimes sell precious goods to pay creditors. Even worse, people will tap their retirement accounts such as 401K or IRA accounts in order to repay debt. While this can seem like a good short-term fix, in reality, it is a terrible choice and one that should be made only after you have spoken to an experienced bankruptcy and debt settlement attorney, who can go over all the options you have.
Why Bankruptcy is a Better Choice
In most cases, bankruptcy is usually a far better solution to your debt problems than cashing your retirement savings. Your retirement accounts are very important to securing your future. Eventually, in every person's life, there will come a time when you are no longer able to work. While social security can help at that point, having a solid retirement account is necessary to ensure anything but the most basic standard of living.
Retirement Accounts are Protected From Creditors Under Bankruptcy Law
The bankruptcy courts understand this and know the importance of having a solid retirement account, and this is why these 401(k), IRA and other retirement accounts are exempt from being liquidated and cannot be used to repay creditors in chapter 7 bankruptcy. (To learn more about how your retirements assets, bank accounts and other property is handled in Bankruptcy, see What Happens to Your Property in Bankruptcy?.)
Pitfalls of Using Retirement Funds Early
Despite the fact that the bankruptcy code lets you keep your retirement accounts, many people will cash them in anyway in a last, desperate attempt to avoid bankruptcy. This is a very bad idea for several reasons including:
- You will usually pay harsh tax penalties for cashing in your accounts, significantly reducing the value of what you will receive and resulting in money lost for nothing.
- You'll lose out on the interest the accounts could have earned and you may never catch up with what you would have made had you left the accounts alone.
- You may not be able to save enough during the rest of the working years you have left to afford a comfortable retirement if you cash in your nest egg today.
Consider the Long-Term Impact
The sale and repayment of debts may be a short-term fix if you can't fully pay off every single debt and if you aren't committed to changing your financial lifestyle. The outstanding balances along with the interest may begin to build back up again if you can't pay off the remaining debt, leaving you with no choice but to declare bankruptcy anyway… and by that time, you'll have lost your retirement money, which you otherwise could have kept. This happens to many people across America every year because they didn't know about their options.
It is important to remember, as you consider all of these points, that bankruptcy protection exists for a reason. It is there to help you when you become overwhelmed with debt. Yes, it might cause a temporary dip in your credit, but someone who is thinking about cashing in their retirement savings may have already taken a hit on their credit. After you file bankruptcy, you'll still be able to get a secured card shortly after and to start improving your credit so you can buy a home and otherwise get loans you need. (Learn more about credit cards and credit repair after bankruptcy.) This minor and temporary damage to your credit is not worth selling out your retirement for. Instead, consult with a bankruptcy attorney, protect your future and take advantage of the rights afforded to you under the law.
To learn more about Bankruptcy vs. other debt relief options, see Is Bankruptcy Your Best Option?. You'll find lots of free legal information on Bankruptcy, Debt Settlement and other alternatives to dealing with overwhelming debts.