Debt and your retirement account: Essential things to know

| Jun 7, 2019 | chapter 7 | 0 comments

Over the years, we contribute to our retirement plans little by little to ensure we can support ourselves after leaving the workforce. And as time passes, a retirement account can become one of our largest assets.

Therefore, it is natural that individuals might worry about the money they have saved when they are struggling with debt or considering bankruptcy.

In most cases, retirement accounts are exempt

Whether someone files Chapter 7 or Chapter 13 bankruptcy, their retirement account is usually safe. There are a few exceptions, but someone’s retirement account is often included in both Kentucky and federal bankruptcy exemptions.

Individuals must often still report how much is in the account, as well as the interest when they take an inventory of their assets. But filing bankruptcy does not usually impact someone’s 401(k), pension or individual retirement account.

Filing bankruptcy after retirement might be a different story

However, creditors may be able to access someone’s retirement account if they file bankruptcy after they retire. But there are ways to manage this issue:

  • Chapter 7 filings often depend on how much extra disposable income someone has. Individuals have the power to adjust the monthly income they receive from their retirement account, and if it is not above their means, then creditors might not touch the account at all.
  • On the other hand, someone might have to use their monthly income from their retirement for their Chapter 13 repayment plan. But they can still adjust their income to preserve money in the account.

Important: Do not use retirement assets to pay off debts

There is one incredibly important piece of advice for anyone facing debts before they retire: It is critical that individuals do not use money from their retirement accounts to repay debts. Since retirement accounts are exempt, individuals likely do not have to worry about their retirement when paying debts or filing bankruptcy.

Moreover, people could face significant penalties if they withdraw money from their retirement before they reach retirement age. According to the IRS, individuals could pay a 10% tax penalty for removing money from their account early.

It may seem like a good idea to use retirement money to pay off debts, especially minor debts. After all, there is often much more still in the retirement account. However, it is often a better idea to keep retirement accounts and debts separate.