Are Pension or 401k Loans Dischargeable?

A significant percentage of retirement plans, like pensions or 401k plans, allow you to borrow money from individual accounts in case of need. One of the most common situations is debtors borrowing money from their retirement accounts to try to pay back their debts. Unfortunately, if these debtors decide to file bankruptcy, the pension or 401K loans they took out will not be dischargeable in Chapter 7. Further, if a bankruptcy was filed, these retirement accounts could have been protected in their entirety since retirement accounts are fully exempt under either federal or New York exemptions in either Chapter 7 or Chapter 13 bankruptcy.

Bankruptcy court views loans from retirement accounts differently than a credit card, a car loan or a mortgage. When you borrow from your retirement account, you are essentially borrowing from yourself, and as result, the loan is not considered dischargeable in Chapter 7 bankruptcy. However, these loans can possibly be included in a Chapter 13 bankruptcy repayment plan, and any amount not repaid at the completion of the 3-5 year plan will typically be discharged. If you have already taken a loan against a pension or 401k account, then Chapter 13 might be the best option, depending on other factors. For many debtors, a pension or 401k account are their biggest assets that should be protected and a bankruptcy filing prior to borrowing money from those accounts would do that.

While borrowing from retirement funds is often seen as a last resort, it should not be. There could be a good reason to borrow against a retirement account in a healthy financial situation, but as a desperate effort to pay bills, borrowing from a pension or 401K will do more harm than good. Realize that if you are considering taking a loan against a retirement account that you have already reached the last straw. Discussing your bankruptcy options should really be the next step.

If you contemplating filing Chapter 7 Bankruptcy or Chapter 13 Bankruptcy, or are dealing with debt problems in Western New York, including Rochester, Canandaigua, Brighton, Pittsford, Penfield, Perinton, Fairport, Webster, Victor, Farmington, Greece, Gates, Hilton, Parma, Brockport, Spencerport, LeRoy, Chili, Churchville, Monroe County, Ontario County, Wayne County, Orleans County, Livingston County, and being harassed by bill collectors, and would like to know more about how bankruptcy may be able to help you, contact me today by phone or email to schedule a FREE initial consultation with a Rochester, NY, bankruptcy lawyer.

Bankruptcy Planning, Debt and 401(k)

Once in a while, I hear from debtors who tells me that they expended all or nearly all of their retirement savings trying to avoid bankruptcy.  Unfortunately, if you spend your retirement funds trying to avoid bankruptcy, you cannot get it back.  If, ultimately, the use of those retirement funds was insufficient to avoid bankruptcy, that money was simply wasted if the debtor still needs to file either Chapter 7 or Chapter 13 bankruptcy.

As I have written previously, 401(k) and most other retirement plans are exempt in bankruptcy. What that means is that if the debtor engaged in some bankruptcy planning and filed bankruptcy before withdrawing retirement funds, the debtor would be able to keep those retirement funds and discharge his or her debts.

I understand why debtors spend their retirement money on debts that would otherwise be dischargeable in bankruptcy. Usually, they want to repay their debts and they will employ any available means to do so. While most debtors are aware of bankruptcy as an option, most debtors try to avoid it.

Since bankruptcy gives you a chance to discharge your debt and protect the assets such as retirement funds, it may be foolish to spend all of your retirement money, and I advise debtors to explore their options before making these decisions.  The most important question that the debtors should ask and answer is whether their necessary and reasonable living expenses and debt payments exceed their take home income on a regular basis. If so, is this going to change because of increased income or decreased expenses in the foreseeable future?

If the debtor is left with a permanent deficit and does not expect it to change, then it does not make sense to withdraw retirement funds to continue to pay down that deficit until there is no retirement money left. The bankruptcy system, both New York and federal exemptions, protects your retirement funds.

If you are contemplating filing Chapter 7 Bankruptcy or Chapter 13 Bankruptcy, or are dealing with debt problems in Western New York, including Rochester, New York, Canandaigua, Brighton, Pittsford, Penfield, Perinton, Fairport, Webster, Victor, Farmington, Greece, Gates, Hilton, Parma, Brockport, Spencerport, LeRoy, Chili, Churchville, Monroe County, Ontario County, Wayne County, Orleans County, Livingston County, and being harassed by bill collectors, and would like to know more about how bankruptcy may be able to help you, contact me today by phone or email to schedule a FREE initial consultation with a Rochester, NY, bankruptcy lawyer.

Should 401k Loans Be Used to Avoid Bankruptcy?

Once in a while I am asked whether 401k loans should be used to pay off credit card debt and, therefore, avoid bankruptcy. In my opinion, it is a bad idea.

Filing for bankruptcy under either Chapter 7 or Chapter 13, is a difficult decision, and most of the time debtors will try to do just about anything to avoid filing. However, if you earn $50,000 in gross income, and you are $50,000 in debt, because of interest and other carrying costs, it is unlikely that you will be able to pay off that debt within a reasonable period of time. Thus, a debtor may think that whatever money he has in his 401k will save him from having to file bankruptcy. Unfortunately, for most people, this is unlikely to come true.

Initially, if 401k loan is used to pay off credit card debts, there is now a significant debt owed to the 401k plan. Usually, 401k loans carry lower interest rates than credit cards. However, while having a lower interest rate, 401k loans have to be paid back over a shorter period of time.

If a loan is taken out and not repaid, it is treated as income, and debtor will incur a 10% early withdrawal penalty since it is a distribution from a tax-deferred plan, and also will have to pay income taxes on the unpaid amount.  Unpaid amount of the loan is treated as additional income, and it is likely to increase debtor’s income tax rates as well.

If you quit working or change employers, the loan must be paid back right away. It’s not uncommon for plans to require full repayment of a loan within 60 days of termination of employment. If you can’t repay the loan, it is considered defaulted, and you will be taxed on the outstanding balance, including an early withdrawal penalty if you are not at least age 59 ½.

However, if the debtor decides to file bankruptcy, under either Federal exemptions or New York exemptions, 401k is completely exempt. If you file for bankruptcy, the credit card debt will be gone, and you will be able to retain the money in your 401k plan.

If you are contemplating filing Chapter 7 Bankruptcy or Chapter 13 Bankruptcy, or are dealing with debt problems in Western New York, including Rochester, Canandaigua, Brighton, Pittsford, Penfield, Perinton, Fairport, Webster, Victor, Farmington, Greece, Gates, Hilton, Parma, Brockport, Spencerport, LeRoy, Chili, Churchville, Monroe County, Ontario County, Wayne County, Orleans County, Livingston County, and being harassed by bill collectors, and would like to know more about how bankruptcy may be able to help you, contact me today by phone or email to schedule a FREE initial consultation with a Rochester, NY, bankruptcy lawyer.