Millions of Americams have built up 401k retirement accounts and IRA’s.  I recently saw an article describing how more and more people have taken out loans against their 401K’s.  As a Ft. Lauderdale bankruptcy attorney, I have routinely seen clients who are strapped by payroll deductions for 401k loans.  Also, I have seen clients withdraw large sums of moneys from IRAs to pay bills.  This creates a tax penalty and income tax liability and also depletes retirement accounts.

Now it may often be true that these loans and withdrawals can solve the debt problem in particular cases.  But all too often these actions merely delay the inevitable crushing burden of debt.  Retirement assets are depleted, income taxes are owed, and the individual still must file bankruptcy. 

I strongly recommend that any one who considers borrowing from a 401k or making an early withdrawal from an IRA first consult with a Ft.Lauderdale bankruptcy attorney or other professional.

As a Fort Lauderdale bankruptcy attorney,  I have repeatedly seen clients attempt debt settlement plans where they pay for months to a company who first retains large sums of moneys as fees and  then holds  funds to try and settle at discounts, one creditor at a time.  Credit is still ruined, the clients often cannot continue to make payments, and the clients need to file bankruptcy after having  wasted their hard earned income.  If you can save money to settle, you can try this on your own.  (Be aware if you do settle you will receive a 1099 for taxable income for forgiveness of debt.)

On July 31, 2010, the Sun Sentinel reported that the Federal Trade Commission is cracking down on debt settlement companies.  Some of these companies have actually stolen client’s funds.  The new rules will prohibit companies from charging a fee prior to a settlement, require safeguarding of client funds in separate accounts, and disclose the time period it will take to settle.  Hopefully, these new rules will prevent abuses that have led to state attorney generals in over 20 states to sue debt management companies.   If you chose a debt management company and plan, be sure you understand the terms of the plan, consider whether the payment terms make sense, and attempt to verify the legitimacy of the company.

Consult an attorney prior to entering any debt management plan.

The  bankruptcy trustee wants your tax refund.  In many cases, the only asset of the debtor is the right to receive the next tax refund,  and you don’t want to be required to surrender it to the trustee.  Plan now.

What does this mean?  It is common practice to want to withhold enough taxes as forced savings so that the individual receives a large tax refund to pay property taxes, insurance, and other expenses.  But in bankruptcy, this savings effort can backfire.  For example, if a debtor files bankruptcy next January, 2011,  the trustee has a claim on the refund and may want to seize it if large enough. And this might go on for several years in a chapter 13,

What if I file a bankruptcy on October 1, 2010?  Can the trustee seize my refund even though I do not file the tax return until 2011? October 1 is 10/12  of the year 2010, so the trustee can keep your case open in 2011 to obtain 10/12 of the 2010  refund.  Plan now.

So as a Fort Lauderdale bankruptcy attorney,  I often advise the client to review the amount of tax withholding to avoid a large tax refund.  Lower withholding provides a better cash flow for current bills and prevents having a large enough refund that the trustee would want to seize. (Of course, I do not give tax advice and you should consult with the person who does your taxes if possible as to the appropriate amount of tax withholding so you do not end up owing IRS.)

Note that in Florida the portion of the tax refund that is from the earned income credit for low income workers is exempt from the trustee.  Don’t confuse this with the child tax credit, which is not exempt.

Bottom line, don’t create an asset for the trustee from your tax refund.