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Should You Take Money Out of Your IRA to Pay Off Debt?

If you’re getting deeper and deeper in debt by the day, the funds sitting in your IRA may be looking pretty good right about now. Perhaps you have big medical bills, thousands in credit card debt, past-due utility bills and you’re barely able to pay your monthly housing expenses. As the sleepless nights worsen, you’re thinking to yourself, “Do I tap into my IRA or do I file bankruptcy?”

It can be tempting to consider your retirement fund as a solution to dig yourself out of the hole, but is it wise? Tempting as that IRA may be, using your retirement dollars to pay off your debt is a bad idea. Why? For starters, you’d be hit hard by hefty withdrawal fees and taxes, very hard. Bankruptcy may be a much better option rather than raiding your IRA.

Don’t Touch Your IRA

We advise that clients avoid touching their IRAs early, even to pay off mountains of debt. The main reason is that when you prematurely take money out of your IRA, that early withdrawal comes at a big cost. When you withdraw funds from your IRA early, before the age of 59 ½, you have to transfer the money into another retirement account within 60 days so it can be a “nontaxable rollover.”

If you fail to do this within 60 days, you will have to pay hefty taxes and penalties to the government. Since it’s your hard-earned money, you don’t want to kiss a lot of it goodbye when bankruptcy could have been a much more financially savvy option.

What about a 401(k)? If someone withdraws money early from their 401(k), they face a 10% penalty. They will also have to pay taxes on what they withdraw, but the IRS standardly withholds 20%.

If you file bankruptcy, is your IRA or 401(k) protected from creditors? “All types of individual retirement accounts, or IRAs, recognized under the federal tax code enjoy substantial protection from creditors during a bankruptcy. Protection for IRAs was signed into law by President George W. Bush under the Bankruptcy Abuse Prevention and Consumer Protection Act, or BAPCPA, of 2005,” according to Investopedia.

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