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Don't Borrow Against Your 401k Without First Speaking With a Bankruptcy Attorney

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  • Don't Borrow Against Your 401k Without First Speaking With a Bankruptcy Attorney

    Any person who is considering taking out a loan against their 401k to pay off credit card debt or medical debt should first meet with a local bankruptcy attorney. As a general rule, borrowing against your 401k is a stupid idea because the potential tax consequences if you default on the loan.

    As a bankruptcy attorney, one of the most common mistakes I see people make is that they will borrow against their retirement to pay off credit card debt or medical debt. Within a few months, they realize that they are not going to be able to make the 401k loan payment. Trying to get by, they skip other important bills like automobile payments and mortgage payments. Down the road, they come to my Dalton, Dallas, Cartersville or Rome office to file Chapter 13 to save their home and their automobile. The reason I feel so bad for these people is because we could have eliminated the credit card debt and the medical debt in a Chapter 13 or a Chapter 7 bankruptcy but now we are stuck with this 401k loan payment that does not fit into the budget.

    Defaulting on the 401k loan is an awful idea because of the tax penalties. When a person defaults on a 401k loan, she will have to pay the government taxes that she otherwise could have completely avoided if she had never taken out the 401k loan out in the first place.

    Here is a typical scenario. A Georgia couple comes into my office who had about $50,000.00 save up in their 401k. After the husband lost his job as a manager in a local business, they slowly borrowed against their retirement to make payments toward their credit cards. (Happens all the time!) Unfortunately, they did not come to see me until they had borrowed against all of their 401k. Not only did they no longer have any money in their retirement, but they also now had over $15,000.00 in tax penalties for the withdrawal. Unfortunately, the husband was not able to find another job. In this awful economy, this scenario is common.

    Your 401k is meant for your retirement and should never be treated like an emergency fund.

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