Retirement Accounts & Bankruptcyby Amy Szilagyi on 07/24/10
If you are seriously considering filing for bankruptcy, it is a very bad idea to empty out your retirement account (401k, IRA, etc.). While it is tempting to take that money to keep you going for awhile longer, there is a good chance that it will end up making your situation worse.
To file under chapter 7, you must meet the income requirements of the "means test," which looks at your income over the last six months. A disbursement from your retirement account will artificially inflate your income. Most bankruptcy districts will disregard the disbursement income, but some count it for means test purposes, even if they don't count it as current income for repayment plans. If they count it as income for the means test, it could push you into a chapter 13 or, at the very least, make it more difficult to get a chapter 7 approved.
Second, if you have the cash from those accounts sitting in a regular bank account, you may not have enough exemptions available to protect all of the money. There is no specific bankruptcy exemption for cash or for checking or savings accounts. So, you must have enough of a general exemption (usually unused homestead exemption) to protect that money. On the other hand, retirement accounts are normally exempt without limit.
Third, if you use the money to pay off some creditors (but not all) and then file for bankruptcy, the court may look unfavorably on the preferential treatment given to some creditors. This is especially true if you use the money to pay off debt owed to family or friends.
Finally, don't forget that any disbursement you take from a retirement account is taxed and penalized. You will pay income tax on the entire amount, plus you will pay a 10% penalty for early withdrawal if you are under age 59 1/2.
The bottom line is that I have had many clients who have cashed out their retirements and still ended up filing bankruptcy. They are much worse off, having given up a relatively large asset that they could have kept.
If you are even remotely considering filing for bankruptcy, talk to a bankruptcy lawyer before cashing out your retirement account.
Click here for more information on filing bankruptcy in Holland, Michigan