Don’t tap retirement fund for everyday debt

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Dear Bankruptcy Adviser,
I am filing for a Chapter 13 bankruptcy to save my house. I am in need of lawyer fees and other money to survive. Will I hurt myself even more if I take money from my retirement account? I can get the funds if I claim a hardship. I understand my 10 percent penalty. But will the creditors or judge look at me as if I am doing something shady when all I am trying to do is survive?
— Rick

Dear Rick,
I can sense that you are in a desperate situation, one that is making you seek short-term solutions to a long-term problem.

Your question is difficult to answer because each state is different. Depending on the state in which you live, you might not be able to protect much of the money you withdraw from your retirement account. If you decide to file for bankruptcy, then your retirement income, while inside the retirement account, should be 100 percent protected. However, the funds might not be protected once you withdraw them.

No, no one — judge, creditors or the trustee assigned to your case — is going to claim you are doing something shady simply because you withdrew money from the retirement account. You earned that money and can spend it as you see fit. Obviously, if you took the money and hid it under your mattress then that would be fraudulent under the bankruptcy code.

You need a 100 percent objective analysis of your financial situation. I can’t say whether it is a good idea to withdraw the retirement money in order to save your house based on the limited information you have provided. For example, you might only have enough retirement money to make mortgage payments for a few months or even a few years. In the end, you could end up still losing your home and spending your retirement income. That would be a horrible result.

I have seen it numerous times where a client withdrew his retirement income prematurely only to delay the loss of his home only by two or three years. The end result was no retirement income and no home. You must consider long-term issues over short-term problems. You need that retirement income after you no longer can work. That might be your only source of income.

Before withdrawing that money, you must consider whether it is more affordable to rent rather than own. I know that could be a demoralizing decision to make because you will have to walk away from your house, but you must seriously consider this alternative.

You need to consult with a professional, maybe more than one. Most attorneys will provide a free initial consultation, and an attorney with any integrity will tell you whether your idea has any chance to work. You might also consult with a financial planner. He or she could review your financial numbers to easily assess your situation. However, to make a decision based on emotion is the worst decision you could make. That’s short-term and nearsighted. I implore you to seek expert advice before making this decision.

To ask a question of the Bankruptcy Adviser go to the “Ask the Experts” page, and select “Bankruptcy” as the topic. Read more Bankruptcy Adviser columns and more stories about debt management.