How To Borrow From 401k To File Bankruptcy

Bells Whistles And Flashing Lights Go OffWhat happens if you borrow too much money from your 401k to file bankruptcy? A client recently created this problem. She desperately needed to file a chapter 7 as the result of a very large garnishment.  With the garnishment, she was unable to come up with the money to file bankruptcy to stop the garnishment.  Her only source of funds was her 401k.

After reviewing the facts of her case, we determined a fee and she was instructed to obtain that amount from her retirement with the idea of paying it back in short order. Well, if a little is good, then a whole lot more is better, right? Not when you are filing bankruptcy.  She had other uses for the money which did not qualify for emergency withdrawal like attorney fees for bankruptcy did.   She borrowed almost $10,000.00.

The original deal was that she would ask that the check be issued in the name of the Cleveland bankruptcy attorney William Balena to expedite processing of the fees.  If that was not possible she was to bring the disbursement check directly to the office to deposit in my trust account.  Instead, she deposited the check into a third party’s account.  That is what caused the bells, whistles and red flashing lights to go off.

Attorney fees, filing fees, and the other expenses associated with filing bankruptcy are alright to pay in advance of filing, in fact, they are required to be paid, even if you have to take the funds from your 401k.   There are a number of reasons that taking too much from your 401k  BEFORE you file bankruptcy is a bad idea.

  1. Ohio exemptions in cash or bank accounts are insufficient to protect the funds.
  2. Bills you spend the, “extra” money on is a preference.
  3. Gifting is not an option

Ohio’s Sad, Little, Inadequate Exemptions

Assuming you have no cash on hand, no bank balance, and no other non-exempt investments you only have an Ohio exemption of $425 in cash or deposits and a catch all exemption known as the wildcard of $1,150 that can be applied to any property.  This totals $1,575. Double that if you are married and filing jointly.  Anything over that is at risk of confiscation by the trustee.  Your 401k is totally exempt if you leave it in the retirement account.  Convert it to cash or a non IRA bank deposit and only a bit over $1500 is safe.

Preference Payments Before Bankruptcy

Paying a bill with the money won’t help either.  You are required to disclose payments you make in the 90 days prior to filing that total over more than $600 over the 90 day period. When you select one creditor over another, or over all others for payment is called a preference.  If you make a preference payment, you lose any exemption you had in the funds, and your bankruptcy trustee will be able to recover all the money to give all your creditors an even shot at it.  Preference payments must be disclosed on the Statement of Financial Affairs which is part of the bankruptcy petition.  If the payment is to a relative there is a one year disclosure and if the payment is large enough the trustee can go back four years to recover the money.  Show mom you love her and pay her back after you file bankruptcy.

Concealment of Assets

How about if you deposit into someone else’s account?  The law thought of this one long ago.  It is still your money.  Someone is just holding it for you.  Want to call it a gift?  Gifts over $100 to non family members, and over $200 for family members must be disclosed on the Statement of Financial Affairs too.  This is grounds for a denial of discharge if you are lucky, if you are not lucky, jail.

Lying In Bankruptcy Petition is a Crime

Let’s just keep it a secret.  How will anyone find out?  When clients suggest this my response is:  “I really like you, and I need some time off, but I don’t want to spend it with you in a jail cell.” Lying in a bankruptcy proceeding is a federal felony.  They don’t prosecute them often, but when they do it is to make an example out of someone.  Avoiding a garnishment and pocketing some 401k money is really not worth losing everything else.   Don’t plan on just going to another lawyer and not telling him about this.   A 401k loan creates a huge paper trail.   The most obvious of which is a payroll deduction.

After You File, You Can Borrow Or Withdraw Whatever You Need

If you need 401k money to file bankruptcy, just do yourself and everyone else a favor and just get the amount your lawyer tells you you need.  After the bankruptcy is filed you can borrow more and use it for anything you want and the bankruptcy trustee can’t do a thing about it.  Just wait a bit longer.

Creative Commons License photo credit: Highway Patrol Images

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Bill Balena

Bill Balena is a Bankruptcy attorney with an office in Westlake, Ohio. I represent consumers in Chapter 7 and Chapter 13 cases. I am also an accomplished dui/ovi trial attorney.

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