New York bankruptcy debtors often have retirement accounts, investment retirement accounts (IRAs) and 401(k) plans with their employers, and they regularly consider depleting those accounts to pay off creditors rather than file bankruptcy. One feature that tempts debtors into doing this is the ability to take out loans against their retirement accounts. Essentially, they are borrowing money from their future retirement to pay for past borrowing—and in a way that avoids paying tax and early withdrawal penalties. A while ago I explained why 401(k) loans can put New Yorkers deeper into debt. The biggest reason not to do it is that New York bankruptcy exempts just about all of debtors’ retirement savings.
So that takes care of pre-bankruptcy retirement-account loans, but what about these loans during bankruptcy? By that I mean: 401(k) or IRA loans debtors take out while in a confirmed chapter 13 repayment plan.
The answer is that debtors in chapter 13 should not borrow money from a retirement account without consulting with their New York bankruptcy lawyer. Chapter 13 bars debtors from incurring new debts while they are making payments on their plans, which makes sense because all of debtors’ discretionary incomes should be directed toward the plan payments anyway and they should have no income left to repay the new 401(k) loan. If a trustee or a creditor finds out about a 401(k) loan, then they will initiate an adversary proceeding against the debtors to declare the loan income that should go to the creditors. The consequences can be dismissal of the chapter 13 case.
Usually a 401(k) loan indicates that the debtor is running into difficulties in the chapter 13 plan, or has suffered a sudden event like an emergency that makes the plan more difficult to complete. When these underlying circumstances are present, then the debtor is better off asking the bankruptcy court to modify the repayment plan, convert it to chapter 7, or ask for a hardship discharge. In these circumstances the debtor keeps the money in the retirement account after bankruptcy.
However, there can be situations in which a 401(k) loan is preferable to these options. For instance, if a debtor is nearing the end of the repayment plan and needs some money to pay for another expense, then the court and the creditors might allow it, and it might be preferable to the alternatives outlined above.
If you are running into financial difficulties whether before or during bankruptcy, then talk to an experienced New York bankruptcy lawyer before touching your retirement accounts.
For answers to more questions about retirement accounts in bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced Brooklyn bankruptcy attorney Bruce Weiner for a free initial consultation.