A recent report from Fidelity brings to light a disturbing trend in our country: record numbers of people are making hardship withdrawals from their retirement accounts, and near record numbers of people are borrowing from these accounts. As your friendly neighborhood bankruptcy lawyer in Colorado, I see this trend happening every day and it both saddens and frustrates me. This is because early withdrawals from your retirement account take from your future while simultaneously enabling your creditors to reach funds they otherwise could not touch.
Despite the “recovery” that government officials and anyone involved in the real estate market like to talk about, unemployment and underemployment are persistently high and the housing market is in full on crash mode. This is not to mention wage decreases, which many employers are handing out like candy. This is leading many people to liquidate or borrow against some or all of their retirement account.
If you are feeling this pinch and considering taking money out of your 401K, IRA or whatever form of ERISA qualified (tax deferred) retirement account you may have, my advice is to stop and consider alternatives prior to touching this money. I don’t mean to say that you should never take money from your retirement account, but you should strive to avoid doing it and view it only as a last resort.
RETIREMENT ACCOUNTS ARE EXEMPT IN MOST STATES
In Colorado where I practice as a consumer bankruptcy attorney, any amount you have in a retirement account is exempt. This means your creditors cannot get it if they sue you. It also means you can keep this asset if you decide to file bankruptcy. By taking money out of your retirement account, not only are you taking from your own future, you are essentially opening the door for your creditors to get something they otherwise have no right to get.
If I had a nickel for every time a client tells me they liquidated a retirement account before coming to see me, well – I probably wouldn’t be rich or anything because a nickel isn’t worth what it used to be with inflation and all – but I’d have a piggybank full of nickels!!
That heavy pig wouldn’t make me nearly as happy as I would be if people stopped liquidating retirement accounts to pay debt.
Of course, the exemption laws vary from state to state, and some states limit the exemption to a certain amount in a retirement account. However, these limits are generally quite high. For example, the federal exemptions (which apply in some states and situations) limit IRAs and Roth IRAs to $1,095,000, and have no limits on other tax exempt retirement accounts such as 401K accounts.
WHAT TO DO BEFORE TAPPING YOUR RETIREMENT ACCOUNT
If you are struggling to keep up for whatever reason and considering getting money from your retirement account, I strongly suggest you consider the following options as alternatives to tapping your retirement account.
Stop paying unsecured debt
Credit card bills and medical bills simply rank lowest on the totem poll of who to pay when you are struggling. If you can free up enough money to cover your necessities by simply not making these monthly payments, you absolutely should NOT touch your retirement account! Period. End of Story.
You may have to file bankruptcy to get rid of those debts, but that is a much, much better option than mortgaging your untouchable, and well deserved, future.
Stop paying secured debts and letting these assets go
For many, stopping your monthly credit card payments is not enough to position you to cover the necessities of life. If this is you, you have some tougher decisions to make.
I suggest you start by looking at your home. In particular, you should look at how much the house is worth (I suggest you look at the low end of the estimate provided by Zillow) versus how much you owe on it. One of my previous blog articles covers this topic.
Many homes are worth less than the amount owed on them, or underwater. And with the real estate market in a free fall (a recent Bloomberg article reports that home sales fell 27% in July 2010, YIKES!), existing underwater homes are sinking into the abyss while many more are falling below the surface. This means it’s a bad time to own a home.
If the federal government can’t prop up the real estate market with all of its stimulus, what good is your 401K??
If your home is underwater, I suggest you consider letting it go before you go pulling money from your retirement account. This may be the best investment decision of your life, especially when you factor in how long you can stay in the home rent-free while the foreclosure process runs its course. In Colorado, homeowners can often stay in the home for 9 to 12 months or more once they stop making payment.
Again, this decision may ultimately require you to file bankruptcy because your home lender may be able to sue you for the difference between what your home is sold in foreclosure versus what you owe (topic of another previous blog post). But if the alternative is throwing your future into real estate losses, this as a small price to pay to help insure your future.
Another asset to consider when working to make ends meet is your vehicle. If I had a nickel for every client coming to me with a high car payment (which I consider be over $450 per month) while considering bankruptcy, my piggybank would be bursting at the seams (even if I wouldn’t be rich!).
Of course, finding a more affordable vehicle may be difficult. If you have bad credit, you may not be able to get into another vehicle. And auto repossession can happen quite quickly when you stop making payments.
But, if you’re going to tap into a retirement account to make a high car payment, a better use of the retirement account funds may be a different car. While a vehicle worth $3,000 or $4,000 may not be as cool as your current ride, it is probably a smarter use of your retirement account funds than throwing them into a bottomless pit – which is what a high car payment is when you can’t afford all of your obligations.
WHEN IT MAKES SENSE TO LIQUIDATE A RETIREMENT ACCOUNT
If these alternatives are not available to you, you are in a situation where you can justify an early withdrawal or a loan against your 401K. Everyone’s gotta eat!
But lots and lots of people are making early withdrawals from their retirement accounts who have better financial options. This is because early withdrawals from your retirement account take from your future while also unlocking your money for your creditors. Because of this, early withdrawals from your retirement account or loans against it should be viewed as a last resort only to be visited after stop paying on unsecured debt, let your home go if it is underwater (and live there rent-free until they foreclose on it), and find something cheaper to drive. Such moves will likely require you to file bankruptcy, but will position you to protect your retirement account while also reducing your current expenses. Now that’s what I call a fresh start!