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How You Can Lose Retirement in Bankruptcy

Don’t lose retirement in bankruptcy. If you have a standard kind of retirement account, like a IRA, 401K, 403b account, it is almost certainly protected in both Chapter 7 and Chapter 13 bankruptcy.

Unfortunately, many people do end up losing their retirement accounts. This can be avoided by proper planning and knowing what to do, and what not to do, with your retirement funds.

lose retirement in bankruptcy

Loss of Retirement Account Due to Poor Planning

Not thinking ahead is the number one way people end up losing their retirement accounts in bankruptcy. More specifically, they don’t lose the retirement account itself. They take the money out of the retirement account first, then then they file bankruptcy.

This is understandable, but the problem can be avoided. This situation happens mainly when you want to avoid filing bankruptcy. Your plan is to use the retirement funds to pay down debt to a manageable amount, which you think you will be able to handle.

What happens next? You get hit with the taxes. Seems that they never withhold enough tax, so you end up with a big tax bill the following years. Then you have another bill you can’t pay. And, this bill is not dischargable in bankruptcy.

Or, you get hit with an unexpected expense. The strategy of using your retirement to avoid bankruptcy works, if everything goes “just right.” You might even have had enough taxes taken out of the retirement to avoid a tax hit. (this significantly reduces the amount of money you actually receive, often as much as 40% is lost!)

When you get the unexpected expense, you may need to file bankruptcy. Of course, taking money out of your retirement before filing bankruptcy does not keep you from being able to file. It’s just sad, heartbreaking actually, when you realize you have depleted your retirement to avoid bankruptcy. You used it to pay bills you could have wiped out in the bankruptcy, so, you lose retirement in bankruptcy.

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Keep Your Retirement Account Safe and Protected From Loss

These are the main ways people lose retirement in bankruptcy. There are others.

A common mistake made is to use a retirement plan withdrawal, like a hardship withdrawal, to pay down a debt, like a car payment, to help with the budget. Depending on your circumstances, this may be OK., But often, I see people pay off large debts, like cars or recreational vehicles, and this creates other problems.

For example, if you have a $20,000 car and owe $20,000 on it, you might have a payment of $600 per month. Your budget sure could use an extra $600 per month. If you had that extra money, you could make your minimum payments, and could avoid bankruptcy. So you take a withdrawal from your retirement fund. Do this not to lose retirement in bankruptcy.

Later, you find you really need to file bankruptcy, but you learn that the $20,000 you HAD in your retirement account, which you used to pay off the car, has created a different problem. The equity you created by eliminating the car loan now keeps you from being able to file a chapter 7, and means you will pay more in a chapter 13. You would be better to reverse this, take a loan out on the car, put the money into a private retirement as much as possible, and then file bankruptcy. So you don’t lose retirement in bankruptcy, or lose as much.

In this example, the retirement plan was not lost in bankruptcy, but it created a problem, a different kind of loss.

There are other ways to lose your retirement in bankruptcy. But, since your retirement is totally protected in bankruptcy, you ought to consult with a bankruptcy specialist before actually taking that loan or withdrawal from your retirement account. Bankruptcy is a better option, most of the time, than using your retirement account to deal with debt.

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