A reader recently wrote to ask if it is a good idea to take cash out from his retirement account in order to pay off his credit card debts. Having been recently laid-off and just receiving unemployment income, he has exhausted his savings. He is now considering taking cash out from his 401(k) account in order to reduce his credit card obligations.
Many homeowners previously had the home equity line of credit as a major source of liquid asset available for easy cash at a moment’s notice. Unfortunately, with the housing price collapse, many have lost the home equity line of credit as a source of easy cash. The only liquid asset left for many individuals are their savings and checking accounts. However, with high unemployment rates, it is very common for many households to also have exhausted their savings/checking accounts and now only rely on their employment/unemployment income as their regular source of cash liquidity.
What happens when our employment/unemployment income is still not enough for our daily needs and to pay off obligations? Those facing unmanageable debts often worry that creditors would run after their assets, including their retirement accounts. Some would even withdraw and spend their retirement accounts in order to prevent creditors from getting their hands on these assets.
This may be a mistake that compounds an individual’s financial difficulties. It is important to know that our IRA and 401(k) retirement accounts are protected from our creditors. Even if an individual files for bankruptcy, one’s retirement accounts are not part of the bankruptcy estate and still remain protected from creditors. Thus, it is generally not a good idea to cash out our retirement accounts in order to pay off credit card debts. Hefty taxes and penalties are involved when we withdraw from our retirement accounts. In addition, when we use our retirement accounts to pay off our credit card debts, we get money from a protected account and pay off an obligation that could easily be discharged in bankruptcy.
Individuals in financial difficulties should talk to a professional about other options before draining their retirement accounts in order to pay off credit card obligations. In this case, it is not a good idea to borrow from our future in order to correct a mistake done in the past.
(DISCLAIMER: material presented above is intended for informational purposes only. It is not intended as professional advice and should not be construed as such. Rey Tancinco is a partner at Tancinco Law Offices, a professional corporation with offices in San Francisco, Vallejo, and Manila. The law office website is at: www.tancinco.com. Rey Tancinco can be contacted at (800) 999-9096 or (415) 397-0808 or via email at: firstname.lastname@example.org