Reasons for Dipping into IRAs
An interesting question cropped up recently on a bankruptcy forum website when a blogger curiously asked, “why do folks dip into their 401K/IRAs before filing for bankruptcy?”
The general consensus to answering the question revolved around the blogger’s admittance that the reason they took money out of their Individual Retirement Accounts (IRAs) before filing bankruptcy was because they were plain ignorant about bankruptcy laws.
- One blogger from the state of Michigan suggested, “I find most people take out these large withdrawals in an attempt to “not” file for bankruptcy, usually to terrible consequences. People just don’t know.”
- A blogger from Florida wrote, “There was no excuse for us–just plain ignorance.”
Another leading factor causing bankruptcy filers to take money out of their Individual Retirement Accounts they filed bankruptcy was their societal conditioned response to feel guilty about not being able to pay their bills when their financial condition was only temporary. The old adage, “hind sight is better than foresight,” certainly must have a realistic meaning to bankruptcy filers who made this mistake.
- An example of a blogger who might have felt societal expectations wrote, “I kept borrowing and doing hardships to save my home and pay off my car, but as you said I should have just filed (bankruptcy) from the early signs of hopelessness.”
What federal law says about IRAs
The U.S. Supreme Court ruled in April 2005 that Internal Revenue Accounts receive Federal Creditor Protection under federal law. This means that creditors cannot seize assets in Individual Retirement Accounts. The Supreme Court ruled unanimously that IRAs should join pensions, 401(k)s, Social Security, and other benefits tied to age, illness, or disability, that are afforded protection under federal law and thus shielded from creditors in bankruptcy proceedings.
One exception to the IRA federal law
Today, there really is not a good reason to raid or dip into Individual Retirement Accounts but for one exception to the federal law. The only debt for which an IRA should be dipped into is to pay a non-discharged tax debt. Even then, you should have resolved to exhaust all your other options before you do. The reason for raiding your IRA under these circumstances is because an IRA is not exempted in a bankruptcy from an Internal Revenue Service levy as described by federal law.
Raiding Individual Retirement Accounts before filing bankruptcy is not a good idea even if you do not have tax debt. Under federal law, you not only will have to pay penalties for early withdrawal on your Individual Retirement Accounts, you will have to pay income taxes on them as well.
If you are facing bankruptcy when you decide to raid your Individual Retirement Accounts, what makes you think you will ever be able to replace the income loss? Who will take care of you when you reach retirement age, and you do not have enough retirement income to live on?
Individual Retirement Accounts are designed to help you when you need it the most in life, in your old age. A bankruptcy can happen to anyone just because of happenstance, but there is really no reason you should raid your Individual Retirement Accounts. That would be caused by you, not happenstance.
- Are Losses on a Roth IRA Tax Deductible? (turbotax.intuit.com)
- What Happens to Pension Accounts in a Chapter 7 Bankruptcy? (betterbankruptcy.com)