Pay off debt with retirement?

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Dear Bankruptcy Adviser,
I have recently become unemployed and need advice on what approach I should take to get out of debt. Here are the specifics: We have (an) income of $4,300 per month, and this includes $2,200 in unemployment benefits. Our debt is a car loan of $18,000 with a monthly payment of $390, four credit cards with a total balance of $78,000 with monthly payments of $1,250 and a mortgage payment of $2,700 per month. My question is: Do I file for bankruptcy or cash in my retirement account of $55,000 and pay off what I can?
— David

Dear David,
You are facing a very difficult decision. On the one hand, you have enough money in your retirement account to pay some of your debt. It appears you qualify for bankruptcy protection, but can you protect your retirement funds while eliminating your debt?

There are three important things to know prior to cashing out the retirement account:

1. Retirement funds are protected, that is exempt, from creditors when you file bankruptcy.
I have filed bankruptcies for clients with over $200,000 in an exempt retirement account while eliminating over $200,000 in credit card debt.

Yes, I have heard people say that this is unfair and unreasonable. Regardless of one’s moral opinion, it is the law. It is hoped you will consult with a bankruptcy attorney and confirm you can protect your retirement money while eliminating your debt.

2. You will pay a penalty when you cash out your retirement funds.
While you can pay a good chunk of your credit card debt with your retirement fund, you will also face a tax liability for withdrawing those funds early. You will have to pay state and federal taxes, and you will lose all future growth of those funds. This is not a decision you should make without great deliberation.

You ought to discuss the tax consequences with a certified public accountant, or CPA, before making that withdrawal.

3. Will you qualify for Chapter 7 bankruptcy or only Chapter 13?
Chapter 7 is called a “fresh start” bankruptcy, which means you eliminate your debt but keep your house and car(s). You ought to confirm whether you qualify for Chapter 7 or only Chapter 13 bankruptcy, which offers a repayment plan of at least some debt over three to five years. This will help you determine all your available options.