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Wondering about your 401K while considering bankruptcy?

The decision to file bankruptcy is not an easy one. There is no "one size fits all" debt relief option, and what works for some might not work for others. For instance, some people might choose to negotiate directly with creditors to make debt payments more affordable. Others could choose to take out a loan from friends or family to pay off high-interest debts, consolidate their debts with a debt management company, or file for bankruptcy.

All debt management options – bankruptcy included – have both their pros and their cons, which is why it is vital to think long and hard about the best method before taking action. An important issue that many people don’t consider when thinking about bankruptcy or other debt relief options is what will happen to their 401K or retirement accounts.

Cash it in?

For people with a significant retirement nest egg built up, it might be tempting to cash out their 401K or take out a loan against it to pay off debt. On paper, that sounds logical and like a good way to free up the income necessary to get rid of debt while still holding on to other personal assets. This method is successful for some people, but there are definite downsides that must be considered.

For example: your age at the time you decide to "borrow" from your 401K or other ERISA-qualified retirement plan is a key component of the decision whether or not this is a viable option for you. If you are in your 30s, chances are good that you will have plenty of time to replenish those funds before you retire, but the likelihood of doing that is significantly lower if you are in your late 50s.

There are other negative financial side effects that could flow from taking funds from a 401K, namely early-withdrawal penalties and tax consequences. It is important to remember that money from a 401K dispersal will be treated as income for tax purposes, and between the tax hike and the penalties, you might be better off just leaving that money alone.

Let it sit?

If you opt for leaving your 401K and retirement accounts intact, remember this: federal laws generally exempt those funds from consideration in a bankruptcy filing. Arizona will generally exempt all but the funds you deposited in the last 120 days before filing. This could mean that you get the debt relief offered by a Chapter 7 or Chapter 13 bankruptcy filing without having to jeopardize your financial future.

Do you have questions about how your 401K will be treated in bankruptcy? Have concerns about the impact of bankruptcy on your credit? Want to learn more about rebuilding your credit after bankruptcy? For the answers to these and other bankruptcy-related questions, seek the advice of an experienced bankruptcy attorney in your area.

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