Is it ever okay to liquidate your 401K?

Confession: Recently, I've been on bad credit card behavior.

So in pondering how I would correct this problem, I seriously, for a 10th of a mille-second, thought about liquidating my 401K (well partially at least, since I probably wouldn't need the whole thing) to completely alleviate the credit card debt I've mischievously racked up in the 2012.

Then a conversation with a colleague-friend came up today about how people finance their living arrangements when they leave a full time job to pursue an MBA at a full time 2 year program. I was naive enough to think that these people just saved up while they were working and accumulated enough to live a "college" lifestyle while they're off the job for 2 years. My colleague-friend quickly corrected me by saying something to the tune of, "Yeah, I used to be like you, and wanted to think people had it all together, but the truth is they usually liquidate their 401Ks to live off of."

This NEVER occurred to me! But since it was brought to my attention, I wondered whether I agreed or disagreed with this method of financing...for the MBAers and credit card spenders like myself.

Unfortunately, I am still undecided. Well, I sort of agree that you shouldn't liquidate...but I understand why people do. In the grand scheme of things, I don't think it would be that detrimental to one's retirement to take $10K- 15K out to alleviate some stress early on in their career. But! This should only be a SINGLE quick fix... not something you do every 5 years. This is a one time deal. And that's where it gets iffy for me because chances are, if it's that easy for you to swim out of your credit card debt, how likely are you be to get right back in it... probably pretty likely.


In reading about it, I didn't find one finance guru who supports liquidating your 401K for any reason other than the absolute last means of survival. Their reasons why:

• Your retirement fund is the ONE thing that creditors can not get to (in most states) even after you file Bankruptcy. Why give them access to cash they are not permitted to go after under any circumstances.
• If you're under 59 1/2 years old, not only does a retirement distribution get taxed as ordinary income (at your individual tax rate) but you also incur a 10% penalty for early withdrawal. While credit card debt can have pretty harsh interest rates, you end up paying a much higher percentage on an early distribution and this almost always outweighs your credit card's interest rate.  
• There's ALWAYS something else you can do first. Instead of going straight for the 401K, you should make changes in your budget in order to live within your means. This way, not only do you dig yourself out of a hole, but you also teach yourself how to stay out of it. Until you have exhausted every other option you should not touch your 401K.

Now that I've written it all...I guess I have ruled this one out...

But...there are reasons you can borrow from your 401K...but the key word there is borrow. We shall talk about that next time.

Until then...

peace.love.soul.

Thirsty Thursdays: Zero Me Out

I received the following question from a reader:

Can you write a blog about bankruptcy one day? I'm baffled by the idea...how does someone's debt just discharged?

Well this takes me wayyyy back...to some class in undergrad where I learned the differences between all of the different types of bankruptcy. While the idea seems simple, it's not as easy to file bankruptcy and be completely dischraged of your debts as you think. Let's take a look:

There are a few chapters of bankruptcy (7, 11, 12, 13), only one chapter discharges ALL of one's debt (chapter 7). The other chapters are for debt restructuring...where you pay off as much as you can with your disposable income and your remaining debt gets restructured to make it more feasible for you to handle.

Chapter 7 bankruptcy is the most commonly filed chapter. This chapter discharges all of your debt with the exception of, taxes, penalties and fines administered by the government, alimony, child support, and student loans. Additionally, the court uses your assets to pay off as much of your debt as possible. This means, even though you lose your debt, you lose ALL of your assets too (except the exempt ones...which are few and far between). However, you can't just file Chapter 7 bankruptcy all willy nilly. You have to be able to qualify by showing that you really cannot afford to pay your debts. If a Bankruptcy Trustee reviews your financial situation and decides that you can pay some of your debt with your disposable income, they can deny your ability to file Chapter 7 and instead force you to file the second most common chapter...13.

Chapter 13 bankruptcy is a financial reorganization organized by the federal court. Basically, the bankruptcy court lays out a plan for an individual to pay off their debt. It's like going to rehab for debt. It still comes with a 10 year credit report punishment, in which you cannot obtain any new loans/financing.

Regardless of what chapter you file, filing bankruptcy is NEVER glamorous. It comes with painful years of horrible credit which could wreck more havoc on your life than you'd think.

Reader, hopefully this has helped your understanding of bankruptcy a bit better.