I read an article on Bankrate.com that said nearly 20% of Americans felt the need to dip into their retirement savings in 2010-2011 to deal with immediate financial needs. Borrowing from your 401(k) or IRA might make sense in some situations, but consumers should consider all their options before making the decision.
One problem with using retirement savings to pay down unsecured debt is that those savings are almost always fully exempt in bankruptcy. This means that your 401(k)/IRA is protected and you will get to keep it despite your bankruptcy filing.
If borrowing $10,000 from your future is going to allow you to avoid bankruptcy and come out ahead in the long run, it’s the wise choice. For example, if you have credit card debt of $10,000 and also have nonexempt assets worth $20,000, a bankruptcy filing would likely cost you more than using some of your retirement savings to settle that $10,000 debt. However, most of the people I see on a daily basis don’t have nonexempt assets. In those cases, the bankruptcy filing is the better choice because it allows the client to discharge the majority of unsecured debt and keep the retirement savings for its intended purpose.
Another problem with using retirement savings to pay down credit card debt is that it is often a temporary solution. Too often, I see people who have tried to avoid bankruptcy by draining all of their retirement savings only to discover that they still can’t afford the payments on the remaining debt. They struggle along for as long as they can, until they are hit with a small claims judgment or foreclosure suit. While a bankruptcy filing can help at that time, the client would have been much better off saving the retirement funds and filing the bankruptcy sooner.
Before raiding your retirement savings, think about your reasons for doing so. If you need the money to catch up on your mortgage payments and keep your house, it’s worth considering (assuming you’re not using your other available funds to pay credit card bills instead of the mortgage). But borrowing that money to pay down credit card debt and to stave off an inevitable bankruptcy for a few months merely delays the fresh start that you need.
Which should be the last resort, filing for bankruptcy or depleting your exempt retirement savings to make credit card payments? I’d really like to read your thoughts in the comments below.
Image credit: Ken Teegardin