If you feel so buried under debt that you want to use your 401(k) to pay your outstanding amounts, there are good reasons to avoid this option. For one thing, you would deplete your retirement savings and expose yourself to financial ruin. The good news is that filing for bankruptcy could let you keep every cent of your retirement money.
Here is an overview of federal laws and the retirement accounts they protect in bankruptcy.
Defined contribution plans
The Employee Retirement Income Security Act shields defined contribution plans from creditor claims. A DC plan is usually a tax-deferred plan offered by your employer. You contribute money to the plan without paying taxes on it. Once you reach 59½ years of age, you can withdraw money from the plan, though you will pay income taxes on the proceeds.
There are many plans which qualify as DC plans, including a traditional 401(k) as well as variants such as SIMPLE 401(k)s and safe harbor 401(k)s. An employee stock ownership plan, a simplified employee pension plan or a SIMPLE IRA can also be a DC plan.
Since individual retirement accounts are not employer-provided accounts, they do not qualify for protection under ERISA. However, the Bankruptcy Abuse Prevention and Consumer Protection Act does protect traditional IRAs and Roth IRAs up to the amount of one million dollars, though inflation adjustments may increase this amount.
In addition, Alabama has its own bankruptcy exemption laws. These exemptions cover many retirement accounts, including IRAs. You may be able to protect more retirement money by using state exemptions.
Bankruptcies involve both federal and state protections. Between them, you might be able to safeguard your retirement while restoring your finances.