How a 401(k) Loan Can Mess up a Las Vegas Bankruptcy

It’s possible for a 401(k) loan to mess up your Chapter 7 Las Vegas bankruptcy. Here’s the scenario. A 401(k) plan is one in which workers deposit some of their income into an account while their employers match their contributions. At six months before their sixtieth birthdays, workers can begin withdrawing money from their accounts without paying a 10 percent early withdrawal penalty and income tax on the withdrawal. However, one of the benefits of 401(k) plans—and one of the most dangerous—is that workers can take instead take loans from their accounts, the chief benefit being that any interest they pay returns to them later.

Bankruptcy attorneys usually discourage people who’ve suffered employment shocks (often a spouse losing a job) from taking out loans from their 401(k) accounts. Sure, there’s no credit check, unlike other loans, and there are no tax penalties so long as the loans’ terms are fewer than five years, but if the account holder loses his or her own job, then they have 60 days to repay the full loan before it’s considered an early withdrawal. Consequently, in circumstances where a spouse loses his or her job, rather than have the other spouse take out a 401(k) loan to prop up a family, bankruptcy attorneys instead encourage the unemployed spouse to file an individual bankruptcy, if possible.

There’s another danger to the 401(k) loan: it can prevent someone from successfully filing a Chapter 7 bankruptcy. Here’s what happens:

  • Debtor takes out 401(k) loan
  • Debtor still can’t make payments on time
  • Debtor files Chapter 7 bankruptcy fewer than six months later
  • Debtor is barred because the 401(k) loan counts as income under the Chapter 7 “means test”
  • Debtor falls into deeper financial difficulties (possibly including foreclosure) until he or she is eligible to refile a few months later.

The point of this discussion is to show that instead of trying to tempt fate by using a 401(k) loan to solve your debt problems, it’s better to consult with a bankruptcy attorney instead. Bankruptcy isn’t a last resort when one is out of all options and faces utter destitution; rather, it’s a mechanism for preventing a downward financial spiral. A bankruptcy attorney may be able to help you better before you take on that 401(k) loan than after.

For more questions about bankruptcy in Las Vegas, please feel free to contact an experienced Freedom Law Firm Las Vegas bankruptcy attorney for a free initial consultation. Call us at 702-602-9886.

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