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I have debt. Should I tap my retirement?

Indebted Americans seeking financial relief often get creative when searching for ways to get out from under their mounting piles of bills and expenses. Some may be tempted to tap into retirement funds like a 401(k).

In general, this is not a good trade-off to make. Unless you are pushing 60, in most cases, you will be penalized 10 percent for accessing these funds early. On top of that, you face federal income tax repercussions when you go to file your tax return.

There is an exception

As with most things in life, there is an exception. A debtor who is still employed may be able to borrow some money from their employer-sponsored retirement plan with no tax consequences. They just have to make sure that they have enough working time left to repay it.

Borrowing retirement money

Taking a loan to pay off your credit cards as opposed to a distribution of the funds can be a viable option in some cases. Of course, you still must be gainfully employed with the company that sponsors the retirement plan in order to do this.

Ideally, if you decide to exercise this option, you should be able to repay the amount within a three-year period. You should also feel assured that you won't face a termination or lay-off in the near future, as that could impede your ability to rebuild your nest egg.

What could go wrong?

A lot, actually. You are likely employed at-will, meaning that your company can fire you for any reason or none at all, as long as it wasn't for a discriminatory practice. And there you'll be, without that retirement account you need badly.

Then, too, if you do lose or leave your job for any reason while the loan is outstanding, you may only have a limited time — 90 days is common — to repay your loan. If you're unable to repay it within those specific time constraints, you will wind up having the unpaid balance treated as if it had been a taxable distribution — the very thing that you were trying to avoid.

An alternative solution

It's often much wiser to leave your retirement alone and simply file for Chapter 7 or 13 bankruptcy. For many debtors, a clean slate is all that they need to once again land on their feet.

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Law Office of Ginger C. Cord, PSC
155 E. Main Street
Suite 330
Lexington, KY 40507

Toll Free: 800-762-6916
Phone: 859-963-2073
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