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Resist the Temptation to Use Your Retirement Accounts to Avoid Bankruptcy

Deitz, Shields & Freeburger, L.L.P. Jan. 21, 2021

It is generally a bad idea to use retirement accounts to avoid bankruptcy.

The news has been awash lately with stories of economic recovery. Whether this is actually the case is up for debate, as underemployment and unemployment remain common problems in Kentucky and Indiana.

Many people in these trying economic circumstances are faced with the foreclosure of their house or garnishment of their wages. As a result, many people are tempted to look to their retirement accounts as a means of paying their bills instead of considering bankruptcy. Although paying off your debt in this manner may seem to be the right thing to do, in reality, it can make your situation worse in the long term.

Raiding your retirement accounts to repay your debts has immediate adverse consequences. When you withdraw your money before retirement age, you incur early withdrawal penalties and tax consequences, which can significantly (and needlessly) eat away your balance and worsen your financial situation.

In addition, it is a poorly conceived idea in most cases to use your retirement funds to avoid bankruptcy, because most of these types of accounts are exempt under the bankruptcy laws. In other words, creditors may not use the funds contained within these accounts as a means of paying off the debt that you owe, if you file bankruptcy. Under the bankruptcy code, exempt retirement accounts include:

  • 401(k)s

  • Individual retirement accounts (including Roth, SEP, and SIMPLE accounts)

  • Deferred compensation plans

  • ERISA pension and retirement plans

  • Government retirement plans

  • Profit-sharing plans

  • Keogh plans

Since creditors cannot reach the funds within these accounts to satisfy your debts, you get to keep the full amount that has accumulated within the account throughout the bankruptcy process. Once the bankruptcy has been completed, most of your debts are discharged and your retirement accounts are intact, allowing you a fresh financial start.

However, if you are considering bankruptcy, it is not advisable to transfer your other funds into your retirement accounts to avoid having to pay your creditors. Once you file for bankruptcy, the court will examine your financial transactions during the period leading up to the bankruptcy. If it finds evidence that you intended to defraud your creditors in this way, it can revoke the exempt status of your retirement account, allowing your creditors access to some or all of the funds within.

An Attorney Can Help

If you are struggling with debt and are interested in learning more about your debt relief options, contact an experienced bankruptcy attorney. An attorney can explain how each option would affect your unique situation and recommend the one that would offer the best protection for your assets.