Retirement assets should not be used as a means of avoiding bankruptcy

Paying off debts with retirement assets instead of filing bankruptcy can worsen your financial situation.

If you are behind on your bills, regardless of the reason, you may be tempted to look to other sources of funds to stave off bankruptcy. For many, tapping into their retirement accounts seems like a good way to pay down debt, stop foreclosure of their homes and prevent repossession of their cars. The reality is that in most cases, filing bankruptcy is not the worst thing that can happen to you financially. In fact, using retirement assets in this manner often leads to a much weaker financial position.

One reason why raiding retirement accounts is a poor way of getting yourself out of a financial jam is that you will immediately have to pay early withdrawal penalties and taxes for the privilege. Immediately, these costs add up and can significantly chip away at what you have worked your whole life to save.

A more important reason why you should leave your retirement accounts alone in a financial crisis is that the majority of these accounts are exempt by law in bankruptcy. This means that your creditors may not use the assets contained within the accounts to pay the debts that you owe. The types of retirement accounts that are exempt include:

• Pension plans

• 401(k)s

• IRAs (up to $1,245,475 per person is exempt for Roth and Traditional)

• 403(b)s

• Keogh plans

• Defined benefit plans

Since these types of accounts are exempt from your creditors' reach, you will be able to keep the full account balance throughout the bankruptcy process. Meanwhile, bankruptcy discharges or reorganizes the debts that got you into financial trouble. Once the process has been completed, you emerge with a fresh financial start without having to use your retirement assets to do so.

Although retirement accounts are exempt during bankruptcy, do not make the mistake of thinking you can protect more of your cash by transferring it into your retirement accounts just before filing bankruptcy. Once you file bankruptcy, the trustee will examine transactions into your retirement accounts during the months immediately preceding your filing date. If there is evidence that you tried to defraud your creditors, the affected retirement accounts may lose their exempt status, allowing the funds contained within to be applied towards your debts.

Speak with an attorney

Since your retirement accounts are protected during bankruptcy, it makes no sense to drain them in order to avoid bankruptcy. However, many people that are irrationally scared of or opposed to filing bankruptcy make this tragic mistake every year, putting their golden years in jeopardy. If you are struggling financially, filing bankruptcy may or may not be a good option for you. An experienced bankruptcy attorney can explain the process to you and advise you whether it is a viable solution for a person in your situation.