Using a 401k Loan to Make Credit Card payments is a waste of money
As I was reading this past weekend, I happened upon this article www.huffingtonpost.com/2010/08/20/401k-hardship-withdrawals_n_688753.html
The article, in no uncertain terms, finds that people are literally raiding their 401k plans like there is no tomorrow. Whats the reason for this? Well, it varies on a case by case basis but typically the average worker does not have enough income to cover expenses. And so the result is that in their peak earning years (35-55), people are taking money out of their 401k’s just to survive. Now, my opinion here deals solely with using 401k money to pay your credit card bills when you have a large sum of debt that you likely will not be able to pay back. Here is why I think it’s a horrible horrible idea:
1. I’ve said it before and I’ll say it again: Filing for Bankruptcy is an emotional decision. If you have a 40k income and you’re 40k in debt, mathematically speaking, due to interest, etc., chances are you’re never coming close to paying that debt back. Which means that, mentally, you’re likely thinking whatever money you have in your 401k will save you from having to file Bankruptcy for some time. That you can make this work. That if only you received a small raise, you’d be fine. You are inevitably wasting money here. Even if you raid your 401k to pay off portions of your credit card debt, you’re still likely to have CC debt leftover, and that debt will accumulate with the absurd interest thats likely being charged. Again, you’re not dealing with the whole issue.
2. Penalties! If you’re taking a loan out on your 401k, not only are you going to have to pay TAXES on it, but you’re also going to forfeit a 10% penalty! Thats a ton of cash to pay off bills that are growing at around a 30% clip in some cases. Plus, now the debt is not unsecured (as it is with credit cards), now its priority debt. You owe Uncle Sam. Uncle Sam comes after your money much more aggressively than most credit cards do. And, unless you have some special circumstances, filing for Bankruptcy WILL NOT discharge tax debts the way it would discharge debts from credit cards.
3. Your 401k is EXEMPT in Bankruptcy. Just in practical terms lets do the math. You owe $40,000 to various credit cards. You have $20,000 in your 401k. You take it out and use it to pay credit cards. You’re still 20k in the hole, now owe taxes and penalties and have 0 retirement savings. Plus chances are your credit isn’t great at this point either. The converse. You file for Bankruptcy in Manhattan, Brooklyn, Queens, etc., you get rid of the $40,000 in debt, you KEEP the $20,000 in your 401k. So now, as opposed to being negative in the thousands, you actually have gotten rid of your debt AND you have money leftover. Really doesn’t make sense any other way.
Again, BEFORE you raid an account thats protected in Bankruptcy, please please speak with a Chapter 7 Bankruptcy attorney in New York. It could and likely will save you thousands upon thousands.