Ask Me Help Desk - 401K loan and Bankruptcy

I have loans for approx. 35,000.00 on my 401k. The payment is 850.00 per month. I am getting separated and have to pay an additional 1500.00 a month, and cannot afford to pay my bills as it is. If I go into either a chapter7 or chapter 13 BK I understand my 401K is exempt, however, is there a way to force a default on my 401k loans? I cannot afford the loans and my employer says they are unable to let me default. They say as long as I am employed there, they have to take out the loan payments from my payroll. Is there anything I can do?

Read very closely the terms of the 401(k) loan. Seems to me, and I am not an atty or an expert on 401(k) plans, but as I think it through, your 401(k) monies are collateral for the loans and essentially you never have to pay the loans back.. the loans will continue to accrue interest and your funds will continue to either accrue investment gains (or losses).. in the event of lackluster investment gains or excessive investment losses, at some point your 401(k) will be worth less than the accumulated loans plus interest and I believe will terminate... I assume you have discontinued payroll 401(k) contributions... but again, I think you have to read the terms of your 401(k) loan or loans. Sorry, I know this didn't answer your question but I believe the answer can be found in the loan agreements.

Bad and dangerous advice in the first answer. As a general rule, if you're not an expert in 401(k), you shouldn't offer advice because it is an incredibly complicated area with severe tax repercussions if handled incorrectly.

I think it through, your 401(k) monies are collateral for the loans and essentially you never have to pay the loans back
Not correct. Your 401(k) isn't collateral on the loan, it IS your loan. If you do not pay the loan back, you will have to pay a penalty for withdrawal - 10% off the top, and then 20% income tax. If your job terminates for whatever reason before you pay back your loan, you will be responsible for those penalties. 401(k) plans were not intended to function as short-term loan opportunities, although many people use them as such. These penalties generally apply even if the participant is in bankruptcy.

You MAY be able to put a stop payment on your loan, but you need to carefully read the loan documents and plan terms to see if that's allowed. Your bankruptcy attorney may be able to help you with this.

Quote:

Originally Posted by BDouxgren

Bad and dangerous advice in the first answer. As a general rule, if you're not an expert in 401(k), you shouldn't offer advice because it is an incredibly complicated area with severe tax repercussions if handled incorrectly.

I think it through, your 401(k) monies are collateral for the loans and essentially you never have to pay the loans back
Not correct. Your 401(k) isn't collateral on the loan, it IS your loan. If you do not pay the loan back, you will have to pay a penalty for withdrawal - 10% off the top, and then 20% income tax. If your job terminates for whatever reason before you pay back your loan, you will be responsible for those penalties. 401(k) plans were not intended to function as short-term loan opportunities, although many people use them as such. These penalties generally apply even if the participant is in bankruptcy.

You MAY be able to put a stop payment on your loan, but you need to carefully read the loan documents and plan terms to see if that's allowed. Your bankruptcy attorney may be able to help you with this.

I suggest you (BDouxgren) read my answer closely as I qualifield my answer (correct or incorrect), by first stating that I was not an expert on 401(k)'s nor was I an atty and I also suggested that the answers could be found in the 401(k) agreements. You did not state whether you were an atty or even an expert but at least I did state my lack of expertise. No one paid me for my answer and I trust they would not take my response as expert advise nor would I expect they to take your answer as expert advice especially since you have no information on your profile nor in your answer. Please do not offend others including me by suggesting the respondent gave bad advice... there is a more polite and professional way to answer questions posed here.

Good point about qualifications - as it turns out, I am an attorney specializing in Employee Benefits, and a member of my state bar, which I should have stated up front. My intent wasn't to insult you personally, but merely to point out that the ramifications for mistakes in this area of law can be devastating, that there was a fairly serious misunderstanding of the law in your response, and to recommend consulting with the OP's bankruptcy attorney. Was I harsh? Perhaps, but I think you will agree that the tax penalties for deemed distributions from a 401(k) account are severe, and it was that severity which prompted my response.