If you lost your job, have had unexpected medical expenses, or a reduction of hours at work, you are probably struggling with paying your bills. You may be looking at ways to keep up with paying your monthly expenses, and if you have a 401(k) you may be considering cashing it in to pay debt or taking out a loan against your 401(k). Before you take this step consider speaking with an accountant or a bankruptcy attorney about your options. Using your retirement income to pay credit cards, medical bills, or other debts can cost you thousands of dollars and jeopardize your chances of having a comfortable retirement in the future.
Your 401(k) is exempt property in most states. This means that the money in your 401(k) is protected from seizure by debt collectors. Cashing in your 401(k) early is expensive. First, you may pay an early withdrawal penalty. Second, when you cash in your 401(k) it is treated as income for that year and you will have to pay taxes on the money. Third, taking money out of your 401(k) costs you future income from the interest it would have accrued. Borrowing against your 401(k) is nearly as bad. If you are struggling with your bills now, it is unlikely that things will be easier once you are required to pay your 401(k) loan payment each month.
If your financial situation is so dire that you are considering using retirement funds to repay debt, you should consider filing bankruptcy. If you qualify for Chapter 7 bankruptcy you may be able to discharge your debt in four to five months without making any payments to your creditors and without losing your retirement accounts. If you aren’t eligible for relief under Chapter 7 you should still consider your options under Chapter 13. This type of bankruptcy will allow you to reorganize your debts. Debtors often pay a fraction of what they owe in this type of case, and even if you are required to pay back all of your creditors, the debts will likely be repaid with no interest.