When people need extra funds to cover their debt they search for money anywhere they can. Eventually, people contemplate dipping into their retirement money. However, cashing out a 401K plan is generally ill advised.
401K plans are the result of your hard work. They provide a certain level of financial security and stability. If you cash your 401K plan out to pay your debts, you are continuing the cycle of losing your financial security.
Further, 401K plans are generally safe from bankruptcy proceedings. However, once the 401K plan is cashed out, creditors can go after these funds to pay their debts. Funds removed from the plan can be seized or garnished by judgment creditors and are subject to seizure by the bankruptcy trustee to pay your debts if you end up filing bankruptcy. In addition, the government will tax you on the money you cashed out and add a penalty if you have not reached retirement age. When you are having financial problems, you do not want to accrue more taxes.
401K withdrawals may also be used to determine whether you qualify for a Chapter 7 bankruptcy plan. As a result, 401K funds withdrawn within six months of filing bankruptcy have to be listed on your bankruptcy filing forms. If you would otherwise pass the means test because you do not make enough money or do not have little enough debt to be able to afford a Chapter 13 bankruptcy, the 401K withdrawals could be added to your income level and could make it so you do not qualify to file a Chapter 7 case.
If you are not actually thinking about retiring any time soon, you should consider filing for bankruptcy as an alternative to cashing out your retirement. Bankruptcy wipes out all your debt. After bankruptcy, you can be debt free and still have your hard earned retirement money and financial security so that you avoid financial problems in the future.
Filing for bankruptcy will leave a negative mark on your credit score, but the impact is not nearly as severe as people think. The bankruptcy stays on your credit for a finite period of time, and most lenders will be willing to extend credit to you after the bankruptcy. Some creditors will take solace in the fact that you have cleared up your financial debt and realize that you are in a better financial situation, which will give them more security in deciding to lend to you.