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Is borrowing from retirement funds allowed during bankruptcy?

Is borrowing from retirement funds allowed during bankruptcy?

Borrowing from retirement accounts not allowed under Chapter 13

Taking funds out of a retirement or credit union account may seem to be borrowing one's own money. However, when it's done during a bankruptcy case, such withdrawals can have serious legal ramifications for those who have filed under Chapter 13.

Court officials view these actions to be the same as taking on new credit, which is prohibited unless authorized by the U.S. Bankruptcy Court. In Chapter 13, debtors agree to pay back creditors for three to five years. Generally, during the life of the case, they aren't allowed to borrow more than $500 without court permission.

All forms of employment-related borrowing, such as using a payroll advance service, are prohibited without authorization from the bankruptcy trustee once the court action is under way and the payment plan begins. Even before a bankruptcy action is filed, dipping into a retirement account is a costly financial move for the borrower.

"At the very least, you need to consider the budgetary impact. That is, can you afford to pay all your living expenses, the Chapter 13 plan payments, and the 401(k) loan payment?" states Matt Berkus, a financial consultant with Methner and Associates, a Colorado law firm.

Detroit bankruptcy attorney Walter Metzen points out on his law firm's website that early withdrawal from retirement funds can result in financial penalties and taxes that cannot be discharged in bankruptcy. Loans taken against a retirement plan prior to filing bankruptcy are also non-dischargeable.

Some court protection

As part of the court's protection, retirement plans are exempt from creditors. But there are situations in which some portion of retirement money may be lost in bankruptcy. It could be partially seized by the court if the plan's money is in a regular savings account or if it is valued at more than $1 million. Any amount over that level may be absorbed into the bankruptcy estate.

While the court's automatic stay stops all wage garnishments initiated by creditors, it doesn't prevent paycheck withdrawals to repay previous retirement plan loans from continuing to be made while the case is active, according to Nolo, a legal website.

Berkus contends that withdrawals from a retirement plan are unnecessary because Chapter 13 provides another option for debtors who encounter a necessary expense not anticipated when the case was filed. "Chapter 13 bankruptcies have inherent flexibility. If something has happened or something has changed, you may modify the plan at any time," he states.

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