How to Use Retirement Funds to Avoid Bankruptcy
Choosing between bankruptcy and taking money from your retirement account is a great example of being caught between a rock and a hard place. Financial planners almost unanimously agree that there are no circumstances in which you want to 'cash out' money from your 401k. Typically, taking money from your 401k results in a 10 percent penalty and you will be required to pay taxes on the money as if it was regular income. Opinions differ on the concept of a 401k loan. While they are still an option of last resort, they can be a good way to avoid foreclosure or personal bankruptcy.
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Instructions
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Figure out exactly what you owe. This number should include all your outstanding credit card debt, home loans, car payments and outstanding bills. Knowing this number will be the basis for all of your future calculations.
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Contact a reputable debt consolidation company. Most financial planners and the IRS recommend exercising every other available option before taking money from your retirement funds. Debt consolidators will work with your creditors to reduce payments and interest rates. Using debt consolidation may negatively impact your credit score but is more favorable than bankruptcy.
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Figure out how much money you need. If you are still employed but simply underwater on your bills, find out exactly how much money you are short each month. Calculate how much cash you need to pay off enough of your debt to eliminate the shortfall. Do not simply pay the minimum payments or the interest. Make sure you are making progress on the principal or you will never get yourself out of the hole.
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Estimate your monthly payments and length of the loan. Most 401k loans cannot be larger than 50 percent of the 401k balance or $50,000, whichever is smaller. You will be required to pay back interest on the loan as well. Interest is paid to yourself and is an estimated equivalent of what you would have earned had the money remained in your 401k account.
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Contact your 401k administrator and begin the paperwork for a 401k loan in the amount you have determined that you will need. In order to qualify for a hardship loan from your retirement account you may need to prove that you are facing eviction or bankruptcy without the assistance.
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Pay the loan back quickly. If you cash out your contributions before paying back the loan the IRS requires you to pay a 10 percent federal tax penalty on the remaining balance.
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Tips & Warnings
Keep in mind that 401ks are protected against bankruptcy. Consult with a financial adviser to determine if a 401k loan is the correct course of action. Bankruptcy is occasionally a better financial decision.
