When bills become overwhelming, frequently people turn to their retirement accounts for help. Sometimes a large withdrawal from a retirement account can appear to be the solution to overwhelming debts. However, it is usually a very bad idea to use retirement funds to pay off debts.
Cashing Out Retirement Causes High Taxes and Penalties
Cashing out a portion of your retirement account to pay bills can result in higher tax liabilities and penalties. You can lose up to 50% or more of your funds just through the additional taxes and penalties you will face. This is a very inefficient way to deal with debt.
Loans on a 401k or similar account create less problems than a withdrawal. Loans on such accounts usually do not cause penalties or new tax liabilities to occur. However, 401k loans are still inefficient due to the interest that you must pay during the term of the loan. These loans are usually not a sound way to deal with large amounts of debt.
Retirement Accounts are “Exempt” in Bankruptcy
In Indiana, most retirement accounts are exempt in bankruptcy. This means that you get to keep all your retirement funds when you file bankruptcy. Therefore, cashing out retirement funds can be an unnecessary loss. If you are facing large debts, you should consider bankruptcy options before making a retirement account withdrawal.
Unfortunately, withdrawals from retirement accounts do not always rectify the entire financial situation. Many people completely deplete their retirement savings only to find out that they still need to file bankruptcy only a few months later. It is usually unwise to deplete retirement savings to pay debts. Speak to a bankruptcy attorney before deciding to withdrawal from your retirement accounts. Such a withdrawal may be a financial mistake.