Questions about 401 (k) and Bankruptcy

If you are filing for Chapter 7 or Chapter 13 bankruptcy, you are undoubtedly experiencing a great deal of stress due to your financial situation. In such times, it’s a natural human reaction to want to pursue the easiest, fastest method of alleviating that stress. Many people, having already sold personal possessions and borrowed from family or friends, see their next (and perhaps their only) option to be cashing in their 401 (k).

In many cases, this might be the worst course of action you could possibly consider. Think of it as trying to stick a band-aid on your present while firebombing your future. Before taking such a drastic step, you should speak with your bankruptcy attorney. Here’s what you need to know about 401 (k) and bankruptcy.

Is My 401 (k) Safe if I Declare Bankruptcy?

The short answer is YES – Your 401 (k) is safe.

As long as you don’t touch it, no one else can.

Many people consider bankruptcy a chance at a fresh start – one that won’t jeopardize your future. If you cash in your 401 (k), you are reducing your chances of a comfortable retirement.

It may be very tempting to cash it in to get creditors off your back. If this is what’s happening, see a bankruptcy attorney who can begin the process of filing for you.  Once this is done, the phone calls will stop because your creditors will be legally prohibited from contacting you.

If you’ve already filed and you’re finding things pretty tight, as probably you will, again, fight the temptation to cash in your 401 (k). We can’t overemphasize this. Live on crackers and ketchup if you have to. Borrow from friends and family – again.

Do whatever you have to do to avoid touching your 401 (k). This is because the funds are only protected so long as they stay in the 401 (k) account, and the minute they’re withdrawn and placed in a savings or checking account, they’re fair game for your creditors.

My 401 (k) Could Wipe Out My Debt and I’d Still Have Money Left Over

That’s great!

But please, again, don’t cash in your 401 (k) – it is still safe.

More than one bankrupt person has walked away from their entire debt and still kept everything they had in their 401 (k). In the hands of a competent bankruptcy attorney, the present will be taken care of. You need to consider the future, if not for yourself, then for your dependents. You don’t want to take what is now, and can remain, a nest egg, and convert it to an asset that is not protected.

If My Employer Declares Bankruptcy, What Happens to My Company 401 (k)?

In the same way that your personal 401 (k) cannot be taken to pay for your personal debts, your corporate 401 (k) is protected. This is because the plan belongs to you, not to your employer.

However, there can be a few complications due to “vesting” requirements. Any money that you contribute to the plan already belongs to you, so it’s already your vested interest. The company’s contribution, however, is still theirs until it’s vested in you.

The danger here is not that your 401 (k) could be used to pay the corporation’s debts. The main problem can be that most corporate plans, if the company is publicly traded, contain at least some company stock. If the company goes under, the value of that stock is diminished. Unless you work for Microsoft or Google or another similar company that’s just “too big to go bust,” limit the amount of company stock that you have in your 401 (k) if you are able.