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The current economic recession has millions of families falling into financial despair. Americans are considering bankruptcy at a nearly unprecedented rate. In addition, there is a growing consideration of a hardship withdrawal of 401k retirement accounts in a last effort to access cash necessary to meet financial obligations and possibly avoid a personal bankruptcy. However, the penalties and taxes charged for prematurely tapping these pension funds may be the least of the obstacles to negotiate before actually obtaining access to the much needed funds.

If one is considering withdrawing from a 401k account and filing for bankruptcy, it may be more beneficial to consider filing for bankruptcy before turning to the 401k retirement account. By law, the 401k retirement account is protected from bankruptcy and all creditors, as long as the money remains in the account before the 59th birthday of the account holder. Anyone holding a 401k account in these economic times should consider the following 1) what to do with the 401k account should changes in employment occur and during a bankruptcy filing and 2) what to consider should the funds within a retirement account come under immediate need during a bankruptcy.

Employees must consider professional management of their 401k in case of loss of employment or change of job as unemployment levels reach record proportions. Employers generally forward the retirement account holdings to the former employee after employment ends. The immediate experience of unemployment may place additional strain on a household’s finances and the temptation to access one’s retirement account early can become even more enticing. However, receiving cash from a retirement account prior to bankruptcy will appear as income and may make qualifying to file for chapter 7 bankruptcy more difficult. In addition, if the retirement account holder becomes unemployed and rolls over the 401k to an IRA or Roth IRA, then depending on the state, the retirement funds may become part of the bankruptcy estate and paid out to creditors. A consultation with a state-licensed financial advisor should be sought in all cases. Each state has differing laws on the bankruptcy estates allowable administration of certain qualified retirement accounts (non 401k) in a bankruptcy case.

If the use of the 401k account funds is needed after filing bankruptcy, the chapter of bankruptcy will determine the process to access the funds. Loans on retirement accounts are popular and allow the account to remain intact without incurring penalties or taxes on the account loan proceeds. Loans on 401k accounts are not able to be discharged in a bankruptcy, they must be repaid. If the loan on a retirement account is requested after a discharge of a chapter 13 bankruptcy, the loan must be approved by the court trustee. It is customary in all chapter 13 filings that any new debt incurred by the filer must be approved by the bankruptcy court trustee and addressed within the payment plan. However, after a chapter 7 bankruptcy is discharged, a retirement account can be collateralized for an un-penalized and untaxed loan or entirely withdrawn minus penalties and taxes, if premature withdrawal is applicable.

Retirement accounts are an often tapped assets as households endure a growing need for cash. However, enticements to access these funds should be avoided without proper consultation by state licensed financial or legal advisers to determine if retirement account plans qualify under the state’s law to become a part of a bankruptcy estate.