There are some things we see over and over that are really not in your best interest. Here’s why:
#10. Using your 401(k) retirement funds for creditors
The IRS tells you it is perfectly OK to “borrow” from yourself out of your retirement funds and pay it back later, even though there will be some associated fines and penalties. Since it is your money, why not borrow from yourself now, and pay it back later when you can?
Why not? In almost every case, the monies in your 401(k) account are fully exempt from creditors. This means the creditors cannot ever touch that money (except for some taxing authorities on certain tax claims). Not only will you have no money later for retirement, you will have to pay taxes, fines and penalties on early withdrawals, and at the end of the day, no matter what else happens, that money would have been there for you. Further, if you end up having to file personal bankruptcy at the end of the day anyway, repayment of 401(k) loans to your own 401(k) account are not expenses available for calculating the means test for ch 7, and under ch 13 or an individual ch 11, you will have a five-year repayment plan to creditors but repaying your own 401(k) account will not be in it.
It might on occasion be a good idea to use some 401(k) money, but only if it is part of a global strategy and global agreement that resolves all creditors issues in a settlement setting or in a bankruptcy, because the creditors acknowledge that you are agreeing to give them some value that they otherwise would not have gotten. Otherwise, please don’t touch your exempt assets and hand them over to creditors on a piece-meal basis.