02 Oct Bankruptcy Planning: Ten Dumbest Things NOT to Do–Part One
As a bankruptcy attorney, a recent headline offering to tell me the dumbest mistakes I could make if I owed too much debt caught my eye. Rarely does a potential bankruptcy client come to me as soon as they get into financial trouble; often they have done things to try and fix the problems themselves that I can only wish had not been done. Unfortunately the headline that caught my eye was only a link to an advertisement that didn’t deliver on the promise, but it got me thinking. Here is my list of the dumbest things you can do if you owe too much money, or, put another way, what NOT to do if you owe too much money.
1. Don’t tap your retirement funds. One frequent mistake made by people in financial trouble is to take money out of a 401k plan or IRA in order to pay things like credit card debt. Retirement funds like 401ks and IRAs are protected from both creditors and bankruptcy trustees. Creditors can’t take that money, and there is a reason for that: you NEED it. The only way that creditors can reach that money is if you voluntarily take it out and give it to them. There might be situations in which using retirement funds to pay debt make sense, but if taking the money out of retirement doesn’t solve the whole problem, (like paying off ALL your credit card debt AND the taxes that you are going to incur for early withdrawal) then it is probably a dumb thing to do. Most of the time my clients have taken money out of retirement and used it to make minimum payments. As a result, they still owe more money than they can pay to creditors, and now they owe taxes, too.
2. Don’t try to pay those loans from family members first. One of the things many people think of doing when they get into financial hot water is to try and pay off family members before filing bankruptcy, or before a creditor gets a judgment. While the impulse to try and pay off those who are close to you is understandable, it may be a very bad idea, for several reasons. It may cost the family member you are trying to protect a lawsuit, depending on when you do it and what happens later. It may eliminate bankruptcy as an option to help you, or make your bankruptcy more expensive. And it may not work–many such payments can be unwound, whether you plan to file bankruptcy or not. A better option is to consult with a lawyer before making any such payments, and find out what kind of problems you may be creating for yourself. If you’ve already done it, consult with a bankruptcy lawyer anyway, and ‘fess up to the problem–what my friend Russ DeMott calls “putting the skunk on the table.” Your lawyer may be able to unwind the transfer and put you back where you started. Many times I can offer clients with family obligations better options, and accomplish the same goal while reducing their risk. One further note–I’m talking about loans from family members, not child support or alimony obligations. Pay the things the Bankruptcy Code calls “domestic support obligations” or some judge may throw you in the pokey.
3. Don’t take money out of retirement to pay off family members. A combination of the prior two bad ideas is a REALLY bad idea. Taking money out of a 401k or IRA to pay back a family loan is the granddaddy of bad ideas when you are in financial distress. Not only do you incur taxes and penalties, but you have taken money that is protected from your creditors (in a 401k or IRA) and made it free game for those creditors, and for a bankruptcy trustee. Absolutely, positively do not do this without consulting a lawyer.
4. Another really bad idea is to transfer assets away when you run into financial trouble. Clients frequently tell me that they have some equity in an asset, and then ask me if they should transfer it to someone else. The answer to that question is almost always “no.” In fact, I can’t think of any exceptions to that rule, but I will leave it at “almost always” in case there is an exception I’ve never run into. Unfortunately, many of the people I talk to have already done that. I don’t call them “clients” because I may not be able to help them, so they don’t become clients. The transfer of an asset to keep it away from creditors is called a fraudulent conveyance, and it can have very serious consequences. It can restrict or eliminate the kind of bankruptcy relief you are entitled to, it can result in more law suits, and it can generally be unwound. And often the asset that was transferred away is one that is exempt, that creditors couldn’t reach anyway, that is, until you transfer it away. That’s right, once you give it away, you are no longer entitled to claim it as exempt property. You can really make a mess for yourself with this one, so don’t do it.
5. Don’t exhaust your savings to pay unsecured debt when your income drops. Note that I used the word “exhaust.” Most financial gurus will tell you that you need an amount in savings equal to your monthly bills for several months (two to six, depending on the “expert). I’m not talking about a situation where you have enough savings to carry you for six months, and you are going to be out of work for surgery for two months. I’m talking about a situation where you’ve been laid off, and you’re facing an indefinite period without sufficient income to live on. Most of us would cross our fingers and try to keep paying everything for a month or two. But don’t continue to try to pay unsecured debt at the expense of paying the folks who can really hurt you, like your mortgage company. If you aren’t sure about which is which, and how you should prioritize the use of your savings, consult with an attorney, or with a financial counselor. How you should set your priorities, and what options you have depend on your individual situation, including your age, your assets, and how much you owe. If you aren’t sure, look for expert advice that is tailored just for you.
Tune in for Part Two, and avoid the mistakes that will cost you in the long run.
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