Can you borrow from 401k in ch 13?

[vleisme]

Has anyone borrowed from their 401k while in ch 13? I know you cannot obtain new credit but that is borrowing your own money so is it ok?

[lrprn]

Has anyone borrowed from their 401k while in ch 13? I know you cannot obtain new credit but that is borrowing your own money so is it ok?

First of all, you will be turning a protected asset into an unprotected asset of cash - potentially risky in Ch 13 if your trustee is one of the more difficult ones.

Second, If you borrow from your 401K now, are you going to be able to pay it back in full within a year to avoid the 10% tax hit at the end of next year?

If the answer is no, then this is not a good plan. Anything you don't pay back not only causes a tax hit, but the IRS considers income for the year as well. Your trustee will see it when he/she reviews your tax returns for the year (unless you are one of the lucky ones with a trustee who doesn't care about tax returns every year).

I think this plan needs a lot more thought about the long term consequences. You also need to get your lawyer's input and blessing for this before you do it.

[wayne-o]

lrprn this is a loan, not a disbursement, so there are no tax consequences for borrowing money (at least not in my plan).

OP I do agree with lrprn about how wise it is to borrow. All of your disposable is supposed to be going to the trustee. Can you really afford the payment?

[vleisme]

I will owe property tax I cannot pay and home insurance, both come due in April, I just filed Nov 1st. Yes, they allow for these expenses in the plan assuming you have a year before they are due to save away the money.I don't know what they expect you to do in this situation and I suppose they really don't care! Trustee said you can not sell anything and borrowing from family is out of the question.

[HHM]

Since you are borrowing your own money, it is not a "new debt" issue, but it is an "expense" issue.

Of course, hindsight, being what it is...this is something you should have thought about BEFORE you filed...but nevertheless.

Plus, can you make the payments on your 401K (which is typically done by payroll deduction) AND your chapter 13 plan and all your other bills.
Other cons...
-The interest you pay on the loan is not tax deductible
-If you leave or get fired from the employer, you must pay the loan back in full, or be subject to tax (thus, ask your self, how stable is your job)
-The payments to the 401K are "after tax"
-And the interest rate on the loan may be low, but you need to calculate the interest rate you would have received on the loan if you had not touched the money.

If you only "filed" on November 1st, then your chapter 13 has not been confirmed, why don't you simply amend your chapter 13 plan to include these debts in the chapter 13. You can do that, at least with the property taxes, since the taxes accrue on a monthly basis.

[MajorMike]

Actually, You are incorrect IRPRN about the tax part but you're right about it being ill advised.

You dont have to pay it back within a year to avoid taxes. You just have to avoid losing your job or it defaults and you have to pay it back with penalties and interest. It's actually a smart thing if you're using the money for a home or to add on to a home to increase value. It's also good for paying your higher interest bills with ( of which you won't have any in a 13 )

The rules:
If your 401(k) plan allows loans (most do), you can borrow up to 50% of your vested account balance or $50,000, whichever is less. You usually have a maximum of five years to repay the loan, unless you are borrowing for a first home, which allows a longer payback.

If you've got a financial emergency, and your only choice is between borrowing from your 401(k) plan or pulling the money out in a hardship withdrawal before you're age 59 1/2, it's a no-brainer. By all means, borrow the money. That's because there is no penalty on borrowing, but there is a 10% penalty on early distributions. Unless you repay the loan, it is considered a premature distribution. You would owe federal and state income taxes as well as that 10% penalty if you are under age 59 1/2.

It's not tax-sheltered money anymore. Whether you repay the 401(k) loan out of your salary or from a bank account, those payments are all made back into the 401(k) with after-tax dollars. So, let's say your monthly interest payment is $300 and you're in the 28% tax bracket. You'll have to make $416 in gross earnings to make the $300 payment. Then, when you retire and take withdrawals, you pay taxes yet again.

[lrprn]

lrprn this is a loan, not a disbursement, so there are no tax consequences for borrowing money (at least not in my plan).

Interesting - this is not what happened in our case.

Over five years my husband made six early withdrawals from his retirement plan, the last one 18 months before we filed. they were set up as "loans" with interest rates attached. We couldn't keep up on the payments to return the money to his account in time, so at the end of the calendar year, we had to pay 10% taxes on what had not been paid back.

We couldn't pay the $2K owed in taxes so added it into our Ch 13 plan when we filed.

Sounds like different retirement plans must have different set-ups for early withdrawal of money.

[lrprn]

Actually, You are incorrect IRPRN about the tax part...

See my answer to wayne-o above in this thread at http://www.bkforum.com/showthread.ph...d=1#post126828

Would love an explanation of why what happened to my husband with his early retirement withdrawals was very different than what you describe.

[CindyLou]

Lrprn,
I am thinking that maybe because you defaulted on the loans they became due and payable in full and then when the end of the year came after you didn't pay you were taxed. Maybe that's the difference...if I am understanding your situation correctly....

from about.com http://financialplan.about.com/od/re...a/401kloan.htm

When you default on a 401(k) loan and have not reached the age of 59 1/2, the IRS treats the loan as a distribution which would not only be subject to income taxes, but an additional 10% early withdrawal penalty as well. This can quickly put a big dent in your retirement savings.

[CATCHMEIFYOUCAN]

Before I filed BK, I had a $12,000 loan (from my 401k) which I had paid down about $2000 through payroll deduction. When I filed Bk13, I was still paying on the loan through payroll deduction. I decided to quit one job, waying all my options so I could convert to Ch7. I had to default on my loan. Even though I had paid down the loan, I defaulted on the full $12,000 and had to pay taxes on top of taxes out the butt hole!

Just my 2 cent of information.

Yeah, every 401kplan is different in every company (I have fidelity BTW). I had $26,000 in a 401k from one company, I ended up quitting and had to decide which company I was going to roll over my plan to (this was way before BK), because I needed to take a loan out to pay off my car. Luckily I called because one company was not going to allow me to borrow $12,000 once the funds were rolled over, while the other company was going to allow it.

[lrprn]

Thanks, Cindy. That is exactly what happened to my husband.

And looking back, this is also what I said in my original post to vleisme....if he/she took out the 401K loan and couldn't pay it back in time, then there would be a tax penalty the next year

I don't know where the discussion got off track, but hopefully we're all back on the same page now.

[CindyLou]

As long as you continue to pay over the 5 years (or the agreed on amount of time) and do not default there is no tax consequence...only if you default....

[vleisme]

In response to HHM
We are in the process of amending pretty much the whole plan. My atty. is awful and and he had so many mistakes the trustee found at the 341 we are about back to square one. Needless to say, I cannot hire another atty at this point. The money for taxes and insurance is in the plan but the amount is divided by 12 and entered as a monthly amount. Are you saying since there is a lump sum due soon and no time to accrue the money needed there is something that can be done in the plan? No we don't have extra money to make the payments on a loan from the 401k it would have to come from the food budget, we would just have to adjust how we live and what we eat.In years past we pulled money from credit cards if needed to pay taxes.

[MajorMike]

Thanks, Cindy. That is exactly what happened to my husband.

And looking back, this is also what I said in my original post to vleisme....if he/she took out the 401K loan and couldn't pay it back in time, then there would be a tax penalty the next year

I don't know where the discussion got off track, but hopefully we're all back on the same page now.

But you said couldn't pay it back by the end of the year, which is incorrect. He has the full loan term to pay it back. It's only when he DEFAULTS that he gets penalized. To answer his question, he can take a loan out in Chapter 13 without penalty as long as he pays it off in 3 years or 5 years ( whatever the loan term is )
If he DEFAULTS, that's where it gets sticky. It got off track because you said if he didn't pay it back within the year, he'd be penalzed.
You are so very right in that it isn't a smart idea!!

"Second, If you borrow from your 401K now, are you going to be able to pay it back in full within a year to avoid the 10% tax hit at the end of next year? " *(This statement isn't true UNLESS he is default ) Our 401K only lets us take 2 loans out at a time but we only have one.

[HHM]

In response to HHM
We are in the process of amending pretty much the whole plan. My atty. is awful and and he had so many mistakes the trustee found at the 341 we are about back to square one. Needless to say, I cannot hire another atty at this point. The money for taxes and insurance is in the plan but the amount is divided by 12 and entered as a monthly amount. Are you saying since there is a lump sum due soon and no time to accrue the money needed there is something that can be done in the plan? No we don't have extra money to make the payments on a loan from the 401k it would have to come from the food budget, we would just have to adjust how we live and what we eat.In years past we pulled money from credit cards if needed to pay taxes.

A bankrutpcy is a bankruptcy, NO creditor, not even the government can violate the automatic stay (until they lift the automatic stay). So if the taxing authority is going to be paid through the plan...then what is the problem. The whole point of chapter 13 is to pay certain debts over time.

Include the taxing authority as a creditor, and list the property tax that is due this month (the lump sum) as a priority debt (which I believe you can). However, I think you are out of luck on the Insurance, that you will have to pay in a lump sum in order to keep that insurance current on the house. The insurance company is not required to continue coverage if you put the debt into a chapter 13 and pay it over time (and they probably won't continue coverage in that scenario)