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Can I borrow from my 401K while I'm in chapter 13?

Taking a loan from 401K plan needs court approval while in bankruptcy.

Before a Chapter 13 bankruptcy is filed, and while it is in progress, legal experts advise debtors not to borrow money from their 401K retirement plan.

Not only is borrowing against a retirement fund a costly financial move, but it has serious legal ramifications if done while in Chapter 13, which requires that debtors agree to pay back creditors for three to five years. When the repayment plan is completed, the remaining unsecured debts are discharged.

While taking money out of a 401K plan is borrowing one's own money, it is viewed in the same light as taking on new credit, which is prohibited in Chapter 13 unless authorized by the U.S. Bankruptcy Court.

Even before a bankruptcy action begins, dipping into a 401K, IRA or ERISA savings and retirement account spells trouble for someone with dire financial circumstances.

"Early withdrawal of these funds makes you liable for penalties and taxes, which may not be discharged in bankruptcy," Detroit attorney Walter Metzen writes on his law firm's website. "ERISA and 401K funds are exempt from creditors in bankruptcy, as are IRA funds [in some states]. If you don't use these funds, you are very likely to have them to draw on after bankruptcy."

Once the Chapter 13 case is under way and the payment plan begins, borrowing money is prohibited without authorization from the bankruptcy trustee. Debtors in a Chapter 13 action aren't usually allowed to borrow more than $500 without court permission.

"The general rule is no new credit without trustee approval," states Matt Berkus, a financial consultant with the Methner and Associates law firm in Colorado. "At the very least, you need to consider the budgetary impact. That is, can you afford to pay all your living expenses, the chapter 13 plan payments, and the 401(k) loan payment?"

Berkus views withdrawals from a retirement plan as a last resort, and believes that within a Chapter 13 plan, another option may be available. "Whatever it is you are planning for that money can probably (and should) be achieved some other way. Chapter 13 bankruptcies have inherent flexibility. If something has happened or something has changed, you may modify the plan at any time," he states.

In addition to taking money out of a retirement plan, court permission is also needed for other employment-related borrowing, such as using a payroll advance service or borrowing from a credit union.

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