Protecting Your 401k in Bankruptcy

Many Americans look to their 401ks as a way to stem the tide of short-term financial issues. According to research by the Employee Benefit Research Institute, nearly 20 percent of eligible participants choose this option, mainly to avoid foreclosure of their home or repossession of vehicles. They borrow against their nest-egg believing that as their fortunes improve, they will not only repay their loan with interest, they will also solidify their retirement options.

Unfortunately, this is commonly not the case. More often than not, employees become trapped in a vicious cycle of needing money to pay other short-term loans and stop contributing to their retirement plans. Also, they forego potential investment opportunities from the money missing from the account. Further, they may also be laid off from their job, thus requiring the 401k loan due and payable, depending on the plan.

Ultimately, employees unwittingly spend away their savings only to find themselves in bankruptcy with nothing to show for their years of hard work.

If you are facing continuous problems making ends meet, using your 401k as a bailout is a bad idea. Employer sponsored retirement accounts are protected assets under the U.S. Bankruptcy Code. Up to $1 million in contributions may be protected. This means that creditors are unable to come after these funds if you file for bankruptcy protection, and the trustee cannot direct you to use these funds to pay debts. This is your money and you should keep it.

As such, if these funds are protected as a matter of law, why whittle them away to pay bills that will ultimately land you in bankruptcy anyway? It’s like following the old adage “throwing good money after bad.”

Aside from the bankruptcy implications, there are a number of tax implications that make borrowing from your 401k undesirable. For options on how to protect your assets from creditors, an experienced bankruptcy attorney can help.