Is my 401k Protected in Bankruptcy?

Everyone hopes to never be faced with bankruptcy. In fact, our financial budgeting, responsibilities and everyday behaviors are meant to ensure it never happens. However, all it takes is a lost job or a failed investment and suddenly it’s a slippery slope from cash and comfort to financial disparity.

With a lack of income, yet a need to make payments on everything from mortgage to your mode of transportation, sometimes your final option before foreclosure is to file for bankruptcy.

Bankruptcy is legally informing your creditors that you are unable to pay them anymore at the current rate and need a new plan.

However, what if prior to your financial difficulties, you started building a 401(k)? Do you have to dive into the funds that have been put away for your retirement?

The predicament is a doubled-edged sword because you’ll face large fees for withdrawing from your 401(k) early, but bankruptcy comes with significant consequences as well.

First of all, there are few things that look worse to a lender or on your credit score than bankruptcy. Lenders examine your payment history, financial stability and current income versus debt.

With the big “B” word on your credit report, your past will continue to haunt you and you can forget any future loans unless you have a new, steady and sizable income.

Another consequence that you’ll face after filing for bankruptcy is high interest rates on everything credit-oriented. Even if you are working your way to re-establishing your credit, you’ll be paying maximum interest rates for a long period of time.

While creditors are permitted to liquidate your assets so they can cover what you cannot pay in the case of bankruptcy, your retirement funds are not accessible. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 prohibits creditors from touching that 401(k) or similar retirement account such as an IRA.

Ideally, you’ll never have to worry about this situation. However, in this case, you have to weigh your options and decide what’s more important: saving retirement funds or salvaging destroyed credit.