Should I Borrow from My Retirement Account to Pay Down on Debts?

Should I Borrow from My Retirement Account to Pay Down on Debts?

The short answer is no. The long answer is still no unless the circumstances are appropriate.

If you borrow money from your retirement account to build a gazebo or replace the roof on your house or even to buy a car it might be a financially sound decision. You have something tangible to show for it – a gazebo, roof, or car. As long as you are paying attention to your budget and not over extended it should be okay. This is not the same as paying off debts.

First we need to look at what kind of debts we are paying. If they are medical bills, credit cards, or personal loans then we might be converting a debt that would be discharged in bankruptcy into a debt that cannot be included in a bankruptcy.

Imagine you have $20,000 in credit card debt and you are paying $700 a month on those cards as the monthly minimums. Every month after you pay on them you put another $500 on them. You are essentially running them up, not paying down on them and you are in the hole every month. But if they were paid off how much money would you have left over?

The math says that if you are paying $700 and still have to borrow $500 on them to stay afloat then if they were paid off you would only be $200 ahead. If we look at that math again it tells us that we only have $200 a month to cover any replacement loan. If we borrow $20,000 from a retirement fund and the payments are $400 over the next 5 years then we are only trading a $500 per month hole for a $200 per month hole.

The first rule of holes is stop digging. Going from $500 to $200 behind each month may seem okay, especially if you can still borrow against the credit cards, but it will just build the debt back up and sink you even further behind. The real problem comes when you eventually have to file bankruptcy and discover that the retirement loans cannot be included in the case. The retirement loans are not debts for the purposes of a bankruptcy and even after the case is filed they will continue to be withheld from your check.

This means that even after a bankruptcy is filed you will still be running behind each month. There may be other ways to deal with this like picking up more hours at work, giving up certain activities or attempting to reduce some of your basic expenses but most of the time people have already done these things before they have borrowed from their retirement account.

You will convert debt that could have been discharged into debt that will not have a chance of sinking you. Please do not do this unless you have weighed all the options, including bankruptcy.

In the scenario above there might be the option of doing a Chapter 7 or a Chapter 13 bankruptcy. A bankruptcy lawyer would go over those options and assuming you still had $200 left over out of your budget you might end up in a repayment plan with $200 per month going to the bankruptcy trustee and your creditors for 36 months. This would be $7,200 total as opposed to borrowing $20,000 from retirement.

Now there might be a circumstance where borrowing from your retirement account to pay off a debt that cannot be reduced in bankruptcy would make sense. There are some vehicle loans that cannot be lowered in a bankruptcy case and you might be better off paying down on the loan before filing a bankruptcy if that is possible. You might also plan on surrendering a vehicle and borrow from your account to buy another without getting a loan from a bank. You might also have a cosigned loan that in some circumstances would be better off paid before filing. The reasons vary but you can talk to a bankruptcy attorney and they can give you an idea of what might be appropriate.

If you have any questions about borrowing from your retirement account to pay off debts please feel free to contact our office and have a free consultation with one of our bankruptcy lawyers in Wichita, Topeka, Lawrence, or Overland Park. We are happy to sit down with you and go over your options.