It pleases me to no end when I get a call from someone I represented in bankruptcy a few years back and I find out they are doing great and are back on their feet. I like hearing from former bankruptcy clients and getting good news.
Often the call from former clients is prompted in because they need something from me to get a loan.
Not all loans are bad, but I start out worried when I hear that they are about to get into debt. Bang! If you hit your head on a low branch once or twice, you’d learn to duck or walk down another path. It is always my hope that filing for bankruptcy helps people get onto a new path with a balanced budget, the ability to save to cover purchases they used to have to finance, and to hear that they also have gotten to the point where they even have enough money to do something a little extra for themselves or are buying a new [modest] home.
The question I got this week was from a former Chapter 7 bankruptcy client who had received a discharge last year. His case was completed and closed, and he had been able to get a fresh start free from overwhelming debts.
He wanted to know if he could take a loan from his 401k retirement which he had exempted in his bankruptcy case.
The answer to his question is:
“Yes. You can take a 401k loan…
but then I can’t help myself from answering the unasked question.
“Can I get a loan now?”
I hear this question a lot, in different forms. When can I buy a house? Am I allowed to get a credit card? Will I be able to get a student loan? Can you recommend a car dealer who will finance a new car for me?
The question he should have asked was:
I’m short on cash and am thinking of taking a loan on my 401k. I wanted to see if I could come talk to you to see if you think that there are options to help me that might be better than that. Do you have time to see me this week or do you have any recommendations for me?
When my clients ask “Susanne, what do you think?” I answer that it is their choice, and they are the ones who must make the decision.
That said, my personal opinion is that it is normally not a good idea to take a 401k loan or to use retirement funds.
- Borrowing from a retirement account is the ultimate act of borrowing from your future to pay for your past or present debts.
Debtors in bankruptcy should not sell or transfer any property while their case is open, without court permission. However once his bankruptcy case was closed, he received his Discharge, and the Final Decree was entered, all of the property he listed and exempted was within his control again. He was free to do as he saw fit.
This client was a not a young man. What little he had in retirement wasn’t enough. Prior to taking a loan that may add to his financial problems, I recommended that he get more advice. If his problem were debts again, then he might need to come back and get legal advice from me.
I have practiced bankruptcy law in North Carolina for over 25 years. It is my job to try to come up with the options and solutions to legal problems. As a lawyer I am able to review any legal defenses, go over laws and consequences, and explain legal options such as filing another bankruptcy.
I can also recommend non-bankruptcy alternatives, settlement, or workouts if they appeared to be good options to avoid filing bankruptcy. The goal is to see if there was something to help get control of the debts rather than borrow and make the problems worse.
- Another risk from a 401k loan is that there can be tax consequences if the loan isn’t paid back and many 401k plans require repayment in full if you leave your job.
If not paid back, then the amount can be turned into the IRS for income taxes and withdrawal penalties.
Some people find themselves stuck in a job to avoid the tax consequences from leaving. Others find themselves in tax trouble when they are laid off – a really awful time to face a big tax payment if you can’t repay the loan in full. Check the terms of your 401k plan for more details or speak to your tax adviser.
If my client was thinking of taking a loan against his retirement, that meant his budget hadn’t stabilized. Something wasn’t working. With a stable budget, he should have been able to have a short term savings fund to cover things that don’t come up every month like home or car repairs, medical issues, and purchases so he didn’t have to finance them.
In general, filing for bankruptcy might be a better option then using precious retirement funds that creditors don’t have access to unless you give it to them. Even though my client had filed before, he might be eligible to file again. If not Chapter 7, then maybe a Chapter 13.
Taking a loan is not the right thing to do if it leaves you without enough monthly income to pay for ongoing expenses while you repay the loan. You shouldn’t do it to pay off debts like credit cards that might be dealt with some other way.
I realize that sometimes someone needs money now and there just isn’t any other choice. You might have to do it, but it is a bad choice to have to make.