Why not cash out 401 k to head off BK?

[alorth]

First, I know this is generally VERY Frowned upon by financial advisors. I get that. But read on.

Spouse and I are mid-40's. We intend to keep our house and live here forever...we have been here almost 10 years already, but just re-fi'd (for the 2nd time) last year to get lower rate and lower payment. So we have 29 years left on mortgage. We took out our equity in a re-fi 3 years ago to consolidate bills and lower cash outflow. So we do not have a 2nd mortgage, but also no equity in house, and the actual value is under what we owe. But since we plan on staying here, that shouldn't matter.

I am unemployed, and cannot resume my past career, but intend on doing something else when I can figure out what something else is, and spouse has a solid and basically safe career in medical.

Eventually, we figure real estate will come back, and since we plan on staying here, we will have significant equity in the home after 20 years of stability and payments.

We can also start a new 401k after we cash out this one, right? Or am I wrong on that?

So what is the harm in cashing it out now to prevent BK?

I know there is a 10% penalty, plus significant Tax implications. But it would save us for now. We couldn't pay off ALL of our unsecured with it, but we could knock out maybe 40% of it and catch up on whatever cc's we are behind on.

Note...we have NEVER been late on a house payment or car payment, and intend to continue paying those as normal even if we do a BK13.

Is it foolhardy to contemplate this 401k liquidation plan instead of bk13?

[tobee43]

we did...and man am i sorry. it would have been one of the only things protected under the bk laws...so...my suggestion is to proceed carefully...

best of luck!

[Flamingo]

First be advised it is your money and you can do whatever you want with it; secondly, no one knows what the future will bring; Thirdly, depending on the amount of money in your 401(k) and if you take it all out as a distribution you are going to get socked hard with taxes plus the 10% penalty that you will have to list on your tax return for the year you took the distribution. You will have to take off at least 20% for taxes for both state and federal so you are looking at losing 30% of your money right off the bat. Also the distribution, depending on how high you are talking, will probably put you in a higher tax bracket as it is listed for income in the year of the distribution so there is a good chance you will end up owing Uncle Sam for the year in question if you do not have enough withheld for taxes. If the money was left alone until you could make withdrawals at age 59 1/2, you would have no early withdrawal penalties, much more money as, depending on what you have the money in, it would increase over that time and lower taxes to deal with.

This will be your own personal decision and will have to live with whatever consequences could come out of this but the decision is yours alone as only you know your total financial and household situation. If you are still undecided, speak with a tax professional or tax attorney who can really lay it out on the line for you.

[HHM]

The real question, why avoid bankruptcy if its the right solution? What are you really afraid of? (odds are, you are harboring some myths or misinformation about bankruptcy).

It would most likely be the biggest financial mistake you could make to withdraw your 401(k) to get out of debt. The only time, and I mean the ONLY time someone should consider doing that is if bankruptcy will end up costing you more than using your 401(k) (and that is probably in 1:100,000 cases where that would be the case).

Also, if you are unemployed, do you really think you would be in a 13?

[alorth]

The real question, why avoid bankruptcy if its the right solution? What are you really afraid of? (odds are, you are harboring some myths or misinformation about bankruptcy).

It would most likely be the biggest financial mistake you could make to withdraw your 401(k) to get out of debt. The only time, and I mean the ONLY time some should considering doing that is if bankruptcy will end up costing you more than using your 401(k) (and that is probably in 1:100,000 cases where that would be the case).

Also, if you are unemployed, do you really think you would be in a 13?

Thanks for replying, HHM.

To answer the first...I went through a Chapter 7 in my early 20's, in the early 1990's, as a single person. It was discharged, but it took awhile to get back on my feet, which I did. I VOWED to myself never to let credit get out of hand ever again, and to never end up in a BK-type situation again. Now that I am, for varying reasons, I feel like a complete and total FAILURE in my life. A 2-time loser, so to speak. One time? I can see that. But 2 times? I can't forgive myself.

That is why I feel so bad about this HHM. I understand its just "business", that its sanctioned in the constitution, that the Banks figure these losses in to begin with, but it just feels so wrong, and unforgiveable that it has happened twice now. I obviously have no self-control, and that feels horrible to admit.

As for your second question about being unemployed, I can honestly say that even if I was working, we would still technically be "bankrupt", though we probably would not be filing, or even realizing how bad the situation is. Going on blissfully ignorant. Oh, yeah I could make the minimums that I can't make now when I was working, but the cc's would never come close to being paid off. We'd be continuing as before, using them for gas, or small things that add up, instead of using cash, because we ran a monthly deficit. When I was working, we were making the cc's monthly payments on time, but we were cash poor, yet I felt OK about that. That's what I mean about blissful ignorance. We wouldn't be facing the inevitable. We wouldn't be TOLD by a representative of the Government what we could, or could NOT, do for the next 5 years of our lives, IF I make it that long.

I could care less about credit rating. Mine was shot anyway, even though we made all on-time payments, because our balance-to-limit ratio was so high, and we had so many accounts, and we were over-extended. We haven't used credit for any MAJOR purchases for awhile now...but it was used a lot for small things the last 2 years.

Its not really about pride so much, as it is about - again - feeling like a 2-time failure. I would never commit a crime because I would NEVER want to even RISK going to jail, yet it almost feels like that's what we face when we give our entire financial life over to the Government....like becoming a ward of the state, living in the Velvet Prison of home. Its like losing our freedom...even if you might say we had essentially lost our freedom anyway because of being tied to those monthly cc payments...but NOBODY was ordering us to do anything, so I feel like that's a big difference.

[LSUTiger32]

I guess I am in the minority on this, but if you can cash it out, take the hit and still pay off all of the debt I would. I would ONLY do it in order to stave off a bankruptcy or a foreclosure. Especially in your situation where you have already filed once and do not really want to it again. It's a question of ethics....if you have for example $500,000 in a retirement account and are about to file BK on $150,000 in credit card debt I just don't see how you can sleep with yourself at night.

If you would like to give some of the details on the amounts I would be glad to walk with you on this. Remember, you can also help some of the tax hit if the debts are in certain categories like medical.

[doudis2]

Before you even try to head down this road I would double check with your 401K plan administrator to see if you even can cash out.

I was thinking about cashing out way before my bkt just too pay down the mortgage. Anyway after going back and forth on the decision, much like you are probably doing now, I inquired. Heck I can ONLY cash out when I retire or leave this company. I can make a permanent withdraw of about 1/2 for home purchase, then only after taking the max loan amount first which just happens to be 1/2 as well. You see, my company made sure that we can NOT treat this money like it is a personal bank account. It is for retirement and that is that from their point of view.

Anyway good luck regardless of your decision.

[helpmeout]

Is it foolhardy to contemplate this 401k liquidation plan instead of bk13?

Since you asked, yes, it is foolhardy to contemplate it. First of all, you stated that you took equity out to consolidate bills. Are you talking about credit card bills? If so, what are your credit card balances now?

And cashing it out isn't even going to make all of the debt go away. All you would have done is taken an exempt asset and give it away. To the creditors and to the IRS.

BTW, one thing that you may want to consider from your statement "Note...we have NEVER been late on a house payment or car payment" is that just because you haven't been late doesn't mean that you can afford it. I was never late on my house payment. I woke up and realized that owning a house that I couldn't afford isn't worth keeping myself in a stressful place. You may want to reconsider keeping the house. Compare what you pay for the mortgage AND upkeep to what you would pay in rent. Either way, you need to take a hard look at where your money is going. Because if cashing out your equity in the house didn't work to solve the problems, neither will cashing out your retirement.

[jmac]

I could of done the same thing but didn't even give it a second thought...I would never be able to build up my account again who knows where SS will be when were 60 your 401k may be the only thing you got...So to take all your money, lose have of it to uncle same and the rest to creditors is not a good decision in my eyes, plus you still have credit, probably haven't learned your lesson and will be in the same boat soon but with no 401k... I will take it as a lesson learned and i did one when i was in my 20's also, keep my 401k pay the CC companies pennies. I hope in 5 years when I'm doing paying i have learned my lesson about being responsible financially even though most my stuff was from someone being sick..I will be on a budget for 5 years and that is something i have never done so we will see, keep your 401k.

[ValleYum]

Spouse and I are mid-40's. We intend to keep our house and live here forever...we have been here almost 10 years already, but just re-fi'd (for the 2nd time) last year to get lower rate and lower payment. So we have 29 years left on mortgage. We took out our equity in a re-fi 3 years ago to consolidate bills and lower cash outflow. So we do not have a 2nd mortgage, but also no equity in house, and the actual value is under what we owe. But since we plan on staying here, that shouldn't matter.

In my honest opinion? In less than 2 years you will be filing the BK. Look at what you wrote (where I emphasized).

I say less than 2 years because you stated that you can only get rid of 40% of your current debt; so in a little over a year (by my calculations), you will have reached the precise point you are at today - without any retirement funding and both of you will be almost 50 years old. Can you fund a full retirement at age 55 AFTER you complete your 5 years of a Chapter 13?

You never answered about the 7 versus 13 though. Are you only considering a Chapter 13 because of your 'guilt' over having previously filed a Chapter 7?

No judgments from me here. I, too, live in a glass house of debt.

I wish you well; no matter what your choice may be.

[spidge]

Before you even try to head down this road I would double check with your 401K plan administrator to see if you even can cash out.

I was thinking about cashing out way before my bkt just too pay down the mortgage. Anyway after going back and forth on the decision, much like you are probably doing now, I inquired. Heck I can ONLY cash out when I retire or leave this company. I can make a permanent withdraw of about 1/2 for home purchase, then only after taking the max loan amount first which just happens to be 1/2 as well. You see, my company made sure that we can NOT treat this money like it is a personal bank account. It is for retirement and that is that from their point of view.

Anyway good luck regardless of your decision.

My company has the same rules. A 401k was not meant to be liquid. I did take the loan and try to pay off those creditors, but in the end it back fired. The trustee averaged my payments over the life of the ch13 resulting in a tough six month period until my 401k loan matures. I even did hardships to bring the 1st mortgage current resulting in a huge tax bill because it becomes taxable income and we moved up into a higher bracket. We fought the BK tooth and nail as I thought it was the worst thing I could do, WRONG!!! We are now in a manageable plan and since I stopped using the 401k bank will have quite a bit left after the BK.
So think long term. It is your decision, but find another way so you will have something at retirement. For instance, if you loose the house and used the 401k to try and save it and file BK you will be left out in the cold with only the money from your last check in your pocket. If you let the house go and file BK you can use a portion of the 401k for a down payment on another home when your ready to purchase. If you can file BK and keep the house without touching the 401k your golden, do it without any regrets. Plan for retirement. We are in our mid 40's and can now plan for the future again. That should be your goal. No temporary fixes will do. Stand your ground and make decisions that will keep you in a solid position for many years to come.

[chrisdfw]

....if you have for example $500,000 in a retirement account and are about to file BK on $150,000 in credit card debt I just don't see how you can sleep with yourself at night....

just fine without the creditors calling all hours of the night to wake me up. The creditors are not going to show up to fund your retirement, and I would rather not depend on the government to do so, and would rather not pay extra taxes to cover other people who paid citibank and are now in medicaid nursing homes because they cashed out their 401k's.

I didn't cash out mine (and it would have covered the credit cards when combined with the accident settlement)

It is very nice of you to offer your advice if someone takes that path, but I want to encourage everyone to avoid it!

I still sleep fine.

[ScaredINMich]

We thought about that too to avoid BK, but I found a investment caculator online that you put in what you have and when you want to retire and it shows you what you will probably have in the account. It was like 2 million dollars!!!!

So, I was willing to risk our 2 million dollar retirement to cash out our $150K and get liquid of about $80K after taxes/penalities, and then I was STILL going to be stuck with more debt. That changed my thinking real quick.

Our BK is due to a business loss, business loan and business credit cards.

[Logan]

We thought about that too to avoid BK, but I found a investment caculator online that you put in what you have and when you want to retire and it shows you what you will probably have in the account. It was like 2 million dollars!!!!

So, I was willing to risk our 2 million dollar retirement to cash out our $150K and get liquid of about $80K after taxes/penalities, and then I was STILL going to be stuck with more debt. That changed my thinking real quick.

Our BK is due to a business loss, business loan and business credit cards.

Using these calculators are important when making decisions. I've been aggressive with my retirement savings over the last few years (lucky timing for me with the market) and I was considering taking my 401k contributions down to 0 (I get no match) since I have other retirement accounts. If I continue to contribute 8K a year at 6% returns I'll have 400K more in my 401K at 65 than if I contribute 0.

Guess what I decided to do?

Logan

[StartinOver]

alorth, you are not a two time loser. You may be learning a different lesson this time around. But don't make this lesson become "pride goeth before a fall." It is truly humbling to face this again, when you thought you had it well behind you in your twenties, I understand that. I understand it because I have been involved in shoveling my way out of near insolvency TWICE before. I didn't file for bankruptcy because of the stigma and because we discovered that if we cut back and cut back and cut back and lived like paupers, we could pay off our credit card debts. They were huge for our income level, but back then it was only a self-discipline issue on the spending. Did it twice, having got in big level of debt for different reasons each time.

This time around, we held out for 3 years, and then the real estate bubble burst and we had salary decreases and finally a job loss did us in. But looking back over the recent 6 years, I see that the same problem I cured in the past (living beyond our means and hoping things would get better before it catches up with us) had crept back in. So although I didn't actually file back then (when it would have been easier as it was before the recent bk law changes), I could consider myself a 3 time loser. But I realize that the point of having to take a lesson multiple times is to finally learn it. And so filing this time and really starting over again... well, the plan is to come out clean and really move on. My lesson is that I need to be ruthless about spending, always and that the only way I can do that successfully is that I will never have a credit card again. Ever.

Do not cut your nose off to spite your face, here. If you cash your 401k and later things are not good for you, you could become a burden on your children who could have to support you because you let your protected assets go, if you're too proud to file bk again. That sounds harsh - I don't mean it to be, I hope that you will stop being that harsh with yourself over filing. It's probably the right thing to do. Don't punish yourself and your family over this by cashing the retirement out.