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401(k) Loans Can Put New Yorkers Deeper into Debt

Starting in the 1980s, 401(k) plans rapidly become one of the most popular retirement savings vehicles for workers in New York and elsewhere. The concept grew to replace the corporate pension because it became more common for workers to move between industries instead of work in just one company.

Here’s how they work, if you didn’t already know. Workers deposit money into the 401(k) account, and often their employers will match their deposits. At six months before their sixtieth birthdays, workers can withdraw money from the accounts without paying a 10 percent early withdrawal penalty and income tax.

Because people have been finding it difficult to get credit, some workers are turning to their 401(k) accounts, not to withdraw from them and take the penalties but to take loans from them. In 2011, according to the Wall Street Journal, 401(k) borrowing reached a record high of 30 percent. The benefits of borrowing from a 401(k) is that the interest goes back to the account, which makes it very cheap compared to other loans, no credit check is necessary, and it only costs $75 for the initiation fee. The early withdrawal and income tax penalties only occur if the loan’s term is greater than five years.

Despite these benefits—especially the interest going back to the account—there are reasons not to take a 401(k) loan. One, borrowers who lose their jobs have sixty days to repay the loan, otherwise it will be deemed an early withdrawal and the full balance will become due. This is bad, and it’s even worse for workers who are under more than six months from their sixtieth birthdays. Second, most people who borrow from their 401(k) accounts do so because their spouses lost their jobs and now the family is relying on one income. In these circumstances, it’s probably a better bet for the unemployed spouse to file bankruptcy. A 401(k) loan would work best for someone who will very likely find work soon, and in this economy that is fairly unusual. Finally, 401(k)s are exempt from the bankruptcy estate, and repaying a 401(k) loan is permissible in a Chapter 13 bankruptcy. Thus, it’s better to let the 401(k) be and file bankruptcy anyway. If worse comes to worse, the fact that there are no credit checks means that borrowing from a 401(k) after bankruptcy is still a viable option, though it’s still not recommended.

401(k) loans are a tempting option for cash-strapped families, but bankruptcy is a better option.

For more questions about retirement income in bankruptcy, the Bankruptcy 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.

Rosenberg, Musso & Weiner, L.L.P
26 Court St # 2211
Brooklyn, NY 11242, USA

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