Hi Folks.  We get this question all the time.  Many 401(k) (and other retirement plans) make it super easy to borrow against them for all sorts of personal needs.  Right now, the average working age American (aged 25-40) is carrying $27,251 in non-mortgage debt.

So when you are looking at those high interest credit cards, it seems like borrowing against your retirement makes sense to get yourself out of debt, but the truth is that all you are doing is moving debt around.  To make matters worse, you are moving your debt to a place that you can't really escape, because technically you are borrowing against yourself.  

The same is true when people take out home equity lines of credit against their homes…they are just pulling their own money out to address a problem that may be much deeper.

When people come to my office for a free Bankruptcy consultation, we take them through a series of questions, ending with a budget.  Of course, the budget is somewhat artificial because the person usually hasn't thought about a household budget before.  But it gets us down to the fundamental problem and that is whether or not there is an appropriate level of disposable income to meet your household expenses and pay off your debt in a reasonable period of time.

The usual answer is “NO”…at the amount of disposable income that most people have, paying very large debt loads is simply untenable, and therefore, if they had borrowed against their retirement, or their home equity, they still have the same problem, but this time they have impaired their own personal safety net.

Your retirement plan is designed to provide you with some income when you reach an age where you don't want to work anymore.  Because you are deferring the income, most states have extremely generous protections for retirement plans (often much more generous than protections for home equity).  Most retirement plans are exempt from seizure or garnishment from your creditors.  In many states, it would not be unusual to find an unlimited exemption for retirement plans in a Bankruptcy, while having some capped amount of equity for a home.  That makes your retirement plan an extremely valuable asset worth protecting whether you file a Bankruptcy or not.

But if you take money out of your retirement, pay off high interest debt, and find yourself in the same problem a year or two later, you will immediately regret having to pay back your retirement loan each paycheck, when you could have simply eliminated the consumer debt in a simple Bankruptcy case.

You can do the same analysis at home.  Start with how much your take home pay is for an entire month.  Then take a piece of paper and add up all of your normal monthly expenses.  Subtract the total of your expenses from your take home pay.  That is your “disposable” income.  Then take that number and divide it into your total consumer debt.  That will give you the number of months it would take to pay off your debt at 0% interest (and so we know the real number will be worse).

For example, let's say your total debt is $30,000.  Let's say your take home pay is $3,000 per month and your total expenses are $2,500 per month.  That leaves us with $500 per month to pay down debt.  Divide the disposable income ($500) by your total debt ($30,000) and you get 60 months…so that tells you that it would take at least 60 months (or 5 years) to pay off your debt (more likely substantially more time with interest).  Most people's credit-worthiness returns within 1-2 years of filing a Bankruptcy so the analysis is pretty clear, and using your protected retirement plan funds to pay off this debt is simply a mistake.

Before you raid your 401(k) or other retirement plan to address your out of control consumer debt, talk to an experienced Bankruptcy attorney who can guide you through the proper analysis to determine whether using your retirement plan to address your debt problems is a lifeline or more of a Band-Aid.