It can be scary to not know how you're going to pay back your credit card debt or how you're going to pay this month's bills. Before filing for bankruptcy, many people wonder if they should cash out their retirement account to help pay back some of their debt. In general, cashing out your retirement account prior to filing for bankruptcy is never a good idea. Retirement accounts are typically protected from creditors in bankruptcy, and they're either exempt or excluded from the bankruptcy estate altogether. Additionally, cashing out your retirement account early could lead to penalties and negative tax consequences.
Reasons Why You Shouldn't Cash out Your Retirement Account Prior to Bankruptcy
Cashing out your retirement account before bankruptcy isn't in your best interest. There are many reasons why you shouldn't cash out your retirement accounts to pay creditors, and one of the biggest reasons is that someday, you're going to need your retirement account. We all grow old, and there's going to be a time when you'll want to retire and enjoy yourself. You won't want to work to pay the bills, but you're going to need money to live in your older years. For those of you who are younger, there may or may not be social security when you get to retirement age, and you can't take out a loan for your retirement.
Another reason to avoid cashing out your retirement accounts is that in Florida, retirement accounts are usually protected during bankruptcy. Because of this, it doesn't make sense to take from yourself and your retirement accounts in order to pay back creditors. Aside from the fact that your retirement accounts are protected, you may put yourself more in debt by cashing out your accounts early. Depending on your age, there may be a penalty associated with closing out your accounts before you hit retirement. Also, if you take money from a traditional IRA or 401k, you'll have to pay income tax on that money. Ultimately, your money would be better off staying in your retirement account where it can continue to grow.
Retirement Accounts That Are Safe in Bankruptcy
Many people believe that they will have to give up most of their property when they file for bankruptcy. While it's true that a Chapter 7 bankruptcy trustee can liquidate your nonexempt assets to pay back creditors, state and federal laws provide exemptions that will protect a certain amount of your property during bankruptcy. Retirement accounts usually have the broadest protections in bankruptcy.
Retirement accounts that are qualified under the Employee Retirement Income Security Act (ERISA) are not considered to a property of your bankruptcy estate, meaning the trustee cannot take them to pay back your creditors. If your retirement account is not ERISA-qualified, it will normally still be protected in bankruptcy. Most retirement accounts that are exempt from taxation under the IRS are also exempt from bankruptcy by federal law.
Although cashing out your retirement account early may seem like a good way to help pay off creditors, it can actually hurt you instead of help you. Since retirement accounts are protected during bankruptcy, you're better off leaving your money in your retirement account before filing for bankruptcy. If you have any questions regarding your retirement account, it's important that you speak with an experienced bankruptcy attorney prior to filing for bankruptcy.