Two years ago I wrote a blog item called 8 Pieces Of Life Changing Advice A Bankruptcy Lawyer Will Give You For Free. The blog was intended as a call to action for distressed debtors to seek legal advice, usually given for free, from a bankruptcy lawyer. One of the most important points I emphasized was that “Without paying a dime a client will learn that … they should not invade their IRA or 401(k)”. My conclusion? The seemingly exaggerated statement that
This is free advice that, if taken, may change the course of lives, families and even generations.
Was this just a puff piece? I didn’t think so then and I don’t think so now, especially with the explosive growth in the equities markets since that blog’s publication in July, 2012. The real truth is that if a family has $100,000 in a protected retirement account when the parents are, say, 45 years old, that money can grow tax free until withdrawals become forced at the age of 70. So if the money grows at 4%, the value in 25 years will be $266,583.63. If the money grows at 7% the value will be $542,743.26. (Source? Future Value Calculator).
Let’s get back to the 45 year old parents with $100,000 in an IRA. They may have income interruption, bills to pay, a struggling business. Do they invade the IRA or consider bankruptcy? If they invade the IRA and spend the $100,000, they will incur a 10% penalty (usually withheld upon an early withdrawal) and then the rest of the $100,000 goes immediately into taxable income, probably forcing the client into a higher tax bracket. If the taxes aren’t paid then and there, the unpaid tax liability (and the interest on the taxes) will become nondischargeable, compelling the client into a likely installment plan with the IRS over several years.
When this happens the balance sheet of the family will become very ugly.
Can they recover in 25 years? Perhaps. If not, then the family will be left not only without the $542,000 they may have had, but also without the extra money the IRS will grab in the years to come after the decision was made to invade the retirement account. This money could have been added to the IRA or 401(k) and further increased the family’s net worth, significantly affecting the course of the lives of the family for a very long time.
For more information, read Extreme Caution: Invading Your IRA or 401(k) to Relieve Money Problems Might Ruin You.