When the Damage Is Done, Why Not Bankruptcy?

17 Jun When the Damage Is Done, Why Not Bankruptcy?

Almost everyone who comes to see me wants to know about bankruptcy–what are their options, what will happen, and they usually want my advice. Recently I spoke to a young woman who had high balances on several credit card accounts. She told me a story that has become all too familiar, of an adjustable rate mortgage, foreclosure, and credit card debt incurred to make ends meet while she tried to sell her home.

We went over her remaining assets, which included a retirement plan. I explained that the money in her retirement plan could not be reached by creditors, and recommended a Chapter 13 plan to restructure the remaining credit card debt.

While we were working toward filing a Chapter 13, she asked what I thought of taking money out of her retirement plan to offer a settlement to her creditors. She thought that, after taxes and penalties, she could offer each of her creditors a settlement of about 1/3 of the outstanding balances. I explained that she was drawing down retirement funds that could not be attached by creditors, and incurring taxes and penalties to boot, but she decided that she wanted to give it a try.

The result after six weeks: no response from any of the credit car companies, and two of them had written off the debt and sent derogatory information to credit reporting agencies. We were discussing our next step, and she asked a very pertinent question–if they’ve already reported negative information on her credit report, why should she do anything other than file bankruptcy?

It’s a good question, and the answer is she shouldn’t. She was willing to pay the price in taxes and penalties if it avoided bankruptcy. But, If the damage is already done, why dip into retirement savings to try to pay? In her situation, it was worth making the attempt, with appropriate planning for those taxes, and for the tax implications of debt settlement. At least she didn’t put a lot of money into a debt settlement plan, only to have the same result.

There is no doubt that declaring bankruptcy is a bad thing, but it may be a necessary evil. Quoted in the Washington Post, Peter Morici, economist at the University of Maryland at College Park, notes that ultimately bankruptcy can be restorative, too. “It’s better to get people a clean slate,” he said, “so when the economy recovers they can participate again.”

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