Bankruptcy is the solution to crushing debt for some consumers

Personal Finance

She said there often is a triggering event — such as a lawsuit filed by a creditor — that makes people realize how much trouble they’re in.

“People really don’t want to have to go the bankruptcy route,” O’Neill said. “They usually do everything they can to avoid it.”

In fact, some end up tapping their retirement savings to stave off bankruptcy. Experts say this is a big no-no and often just delays the inevitable.

For starters, retirement assets — including 401(k) plans and individual retirement accounts that you own and contributed to — generally are protected in bankruptcy. (Inherited IRAs do not get the same protection.)

An exception to this broad rule applies to IRAs, both traditional and Roth: Up to a set amount per person — currently about $1.28 million — is safe from creditors. Any excess could go to pay off creditors. Additionally, if you already receive retirement income, that money is not necessarily protected in bankruptcy.

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Meanwhile, if you are younger than 59½ and turn to your retirement assets to pare down debt, you will pay an early-withdrawal penalty of 10 percent unless you meet one of a few exceptions. That’s on top of paying ordinary income taxes on the distribution.

“The most significant thing to avoid is using retirement funds to pay back debt,” O’Neill said. “If you can come out of bankruptcy without debt but with your retirement savings still intact, you’ll be in a [more] stable financial place.”

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