Should I Use My Retirement Savings to Pay Off Debt?

It’s a normal progression.  Many folks struggling with debt get to a point where they start considering using their retirement savings to get out of debt completely or significantly reduce the total balance owed.  

Folks ask us all the time: Should I use my retirement savings to pay my debt? 

As a bankruptcy lawyer, I know that most folks can protect their retirement savings and get out of debt by filing bankruptcy.  I don’t know about you but that seems like a win-win.  The reason why federal bankruptcy law allows you to protect your retirement savings is that the idea behind bankruptcy isn’t to make you destitute.  In fact, it’s quite the opposite.  Bankruptcy is meant to provide you with an opportunity to have a better future.  Allowing you to keep your retirement savings is a perfect example of this.

Three Problems With Using Your 401(k) to Pay Off Credit Card Debt

1. First, you’re discounting your future in favor of the present moment.  In your defense, this is something we all do. But the consequences in this instance could be pretty significant because you’re sacrificing income that you’ll need in the future so that you can use it now.

2. Second, this strategy often just doesn’t work. Depending on how much you owe, it can be extremely difficult to pay off credit card debt even after throwing a significant chunk of your retirement savings at it.

3. Third, the money you withdraw from your retirement savings may be treated as income when tax time rolls around, meaning you could have to pay taxes on it.  For many folks, using retirement savings to pay off debt turns out to be much more expensive than it initially appears.

We regularly work with folks who try this strategy, live to regret it, and ultimately end up as our clients filing bankruptcy.  That’s the part that really hurts because, in those instances, it’s really easy to see how they would’ve been better off just filing bankruptcy earlier.  If they had, in many instances they would’ve saved all of their retirement funds.

Why You Should Consider Bankruptcy Before Withdrawing From Your 401(k)

And this is the real problem with using your 401(k) to pay off debt.  Many retirement accounts are protected from creditors in bankruptcy.  When you withdraw those funds to pay off your debt, you take protected money that was intended for your future, give it away, potentially pay taxes on it, and use what's left to pay debt that might have been discharged anyway.

You owe it to yourself, and your future self, to know the specifics of your available options.  Talking to a bankruptcy lawyer can help you understand your options, and it doesn't mean that you have to file bankruptcy.  But if you’re considering sacrificing your retirement savings to get out of debt, it’s probably a good idea to know if you have the option to get out of debt and keep the money you’ve saved for retirement.  It’s hard to look at those options side by side and say that getting out of debt and keeping your retirement savings isn't the better option.

If you're in Central Texas and considering using retirement savings to deal with debt, schedule a consultation with us before you take the money out. We'll help you understand what bankruptcy would look like in your situation so you can compare your options.