Many clients come into our office after they have fully liquidated their 401(k) or other retirement plans to try to fully pay off their creditors. After that, they realize that the funds were not sufficient to do such. Further, they soon realize that that the tax penalties and burdens associated with liquidating a large 401(k) Plan put them (or kept them) in even more “hot water”. Only now, the debt to the IRS is nondischargeable.
Before you liquidate an IRA, 401(k) Plan, 403(b) Plan or any other type of retirement savings in order to pay bills, it is appropriate to speak with an attorney as to the consequences of your actions. Congress made a very clear statement that as between paying creditors and preserving your retirement accounts, the retirement accounts should be preserved. This is, no doubt, to make sure that when you reach retirement age or are otherwise no longer able to work, that you do not become a ward of the state because you no longer have retirement savings to support yourself. 401(k) and other retirement plans are fully or a major part is protected from being taken by creditors or the bankruptcy trustee.
If you know that a nominal withdrawal of 401(k) assets will get you “over the hump” and on your way to financial recovery, this may be a prudent use of your retirement savings. If, on the other hand, you were contemplating withdrawing all your retirement savings to pay back only some of your debts and after reading this section you are not convinced that you are making a dent in your credit obligations and doing something other than simply destroying your retirement savings, you need to speak with an attorney before pursuing this course of action.