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Is tapping your 401(k) plan a good alternative to bankruptcy?

Virtually no one wants to file for bankruptcy. It is far preferable to have manageable debt and generous income streams. However, that is not always realistic. If you are considering tapping into your 401(k) to avoid a bankruptcy filing, it may not be a good move.

For one thing, you will likely be able to keep your retirement plan during and after bankruptcy. That means no one has to go into it to pay off, say, your credit card debt. The tens of thousands or hundreds of thousands of dollars in the account are yours. If you take that money (or some of it) out to pay down debt, you could be incurring tax penalties, and you are hurting account earnings in the long term. Plus, it may not make enough of a dent, and you will end up filing anyway. For another thing, there are other alternatives to try first.

Negotiating your debts

Approaches such as debt negotiation can be much more effective than tapping your 401(k) and do not come with dire long-term consequences. With debt negotiation, a debt settlement company contacts your creditors such as credit card companies to get your balance lowered or your monthly payments lowered.

Credit card companies may agree to lower payments because you filing bankruptcy likely means that they get a pittance, if anything. They would rather get, say, 75 percent or even 50 percent of what you owe them than 0 percent.

Modifying your mortgage

If a large portion of your debt comes from mortgage payments, then mortage modification may be a great help. You will have to submit paperwork such as a hardship letter, budget and paycheck stubs to your loan servicer. The process can also be slow and sometimes frustrating, but in the end, your chances could be good of getting to stay in your home and getting in better control of your debt.

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