You may think your loss or reduction of income is only temporary – and hopefully you are right.  But there are better ways to handle bills than to use your 401(k) or IRA.  Don’t do it.

This is really a lesson in waiting too long for help.

So many people over the last several years, mostly people in their late 40’s or early 50’s, come to me for help with a foreclosure or wanting more information about seeking the help of bankruptcy after struggling for a couple of years to make ends meet during times of unemployment or underemployment.  In many of those situations, particularly with families where one or both wage earners had decent jobs and had accumulated a nice amount of retirement savings, using a 401(k) or IRA to pay bills can be extremely painful.

I Had A Great Job and Have Years Of Experience.  I’ll Find Something Just Like I Had Before. In today’s world of employment, the skills necessary to compete have changed drastically and seemingly overnight.  Many people in their late 40’s and 50’s, although they have tons of experience in their careers and have been paid well for it, find they just are not what employers today are looking for.  But, it takes sending hundreds of resumes and going on some interviews to find this out.  In the meantime, because you have been trained to do the right thing, you may make some bad choices in trying to pay bills during this period of time.

I Want To Do The Right Thing.  The right thing means taking care of yourself and your family now and in the future.  You worked hard to save for retirement and if you are in your 40’s or 50’s, it is going to be next to impossible to replace the savings you had if you use it to pay bills that can be handled a better way.  Bills are coming due and you want to make payments.  In fact, many people will put everyday expenses on high interest credit cards, even open one or two new accounts to tap into even more credit.  Others will use savings to pay the mortgage and then to pay the credit card bills.  And, some, after savings are depleted will raid their retirement savings to make ends meet.

Why Not To Use Your 401(k) or IRA to pay bills!!

Retirement savings is protected in bankruptcy.  Yes, I know, you are not thinking about bankruptcy right now and never want to, but bankruptcy is one of the most-used tools for people to recover from a loss of income and save a home from foreclosure.

Focus on the Secured Debts Not Unsecured Debts.  You should distinguish between secured and unsecured debts.  Secured debts debts whose payments are secured by your assets such as your home.  Unsecured debts mean the creditor has no recourse other than money to be paid.  You should make careful use of this distinction and focus on your secured debts.

Paying Credit Cards is The Wrong Choice.  Credit card debt is unsecured debt and in a bankruptcy, unsecured creditors get paid very little or perhaps nothig.  This means you can better use your now limited resources to save your home from foreclosure rather than keep your credit cards current and the phone ringing from debt collectors.

Don’t Pay Your Second Mortgage.  I hear it all the time from a family in foreclosure on their first mortgage, “I have been paying my second mortgage.”  It very well may be the case that your second mortgage can be reduced or eliminated while still saving your home from foreclosure.  In a Chapter 13 bankruptcy, it may be possible to “strip” a second mortgage turning it into an unsecured debt and then paying little or nothing toward it.  Sometimes, this is the difference between getting a loan modification and not getting one.

There are severe penalties to taking early withdrawals from your 401(k) and IRA.

To make matters worse, if you do choose to use your 401(k) or IRA to pay bills, there are severe penalties to pay when you do your taxes that year.  So, not only are you paying bills you may not need to, and you are losing the savings you worked so hard for in the first place, now you have to pay a big penalty when you take an early distribution from your 401(k) or IRA. And, don’t forget you now have to pay income tax in the funds you are withdrawing since it was put into the account ta-free at that time.

Know Your Rights Before You Use Your 401(k) and IRA to pay bills.

Do the best you can do with the resources you have but do not use your retirement savings.  The government protects your retirement savings because it recognizes the difficulty you are going to have in the future if you deplete it now.  As you can see here, there are a number of things you may not have known about your retirement savings. Given the protections available to you, the heavy IRS penalties and tax consequences, and perhaps most importantly, your ability to replace the retirement savings later, using your 401(k) or IRA to pay bills is a very wrong thing to do.