A debtor recently blogged on a bankruptcy forum website his trustee and bankruptcy judge wanted him to take money out of his 401(k) plan to make a balloon payment on one of his creditor’s notes. There is something fishy about the idea any federal representative would ask a debtor to do such a thing. Can a bankruptcy judge ask you to take 401(k) monies to pay debts in a bankruptcy case?
401 (k) Retirement is Federally Protected Plan
A 401(k) plan is an employer-provided and defined contribution pension plan. The plan is considered a protected asset under both state and federal laws. Creditors armed with court judgments can seize funds and cash from checking, savings, and even brokerage accounts, but they cannot legally touch 401(k) funds that have been legally collected.
There are circumstances a bankruptcy judge might go after 401(k) funds, but they are rare. If a 401(k) account is started during the bankruptcy process, and a judge suspects there is an attempt to hide funds in a 401(k), the court may demand the money be brought back to the debtor’s possession to be distributed amongst creditors. If a debtor is formally charged and convicted of a fraudulent attempt to hide funds available to creditors in a 401(k), theoretically and also very rare, the debtor could face prison time and fines.
Technically, 401(k) money should be the safest investment vehicle to hold through any bankruptcy process. Many of your other assets can be taken from you during the bankruptcy process, but it would be very difficult for you to ever lose a protected retirement account.
Can You Use 401(k) Money to Pay Creditors?
Most 401(k) plans allow you to borrow against the account and pay back what has been borrowed over time. You are normally required to pay yourself back a certain percent of interest when you do. These laws are made for your protection to help you better prepare for retirement days.
Technically, you can take out your 401(k) monies and spend the money for whatever reason, including paying creditors, as long as you meet the rules of the plan withdrawal. Often, retirement plans include heavy penalties for early withdrawal. Once withdrawn, income taxes comes into play that can also include penalties for early withdrawal.
It is never a good idea to make withdrawals from a 401(k) to pay off creditors. Can you use 401(k) money to pay creditors? Yes, but it is never a good idea because you are robbing your future to pay for bad financial situations that there are better ways to handle.
Can a Bankruptcy Judge Ask You for 401(k) Money to Pay Debts?
Unless fraud has been committed and proven in placing money into a 401(k) plan, there is no other legal way a bankruptcy judge can force a debtor to use these types of retirement funds to pay a debt. Can a bankruptcy judge ask you to use or borrow against your 401(k) funds to pay debts? Maybe, but if one really has, I would have to believe their suggestion would be unprofessional at best and illegal at worst.
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