In this tough economy, there are many struggling with the decision of whether to cash out retirement funds to pay off debt or consider the option of bankruptcy. While bankruptcy still has some stigma attached, that stereotype is vanishing as more and more people find themselves desperate and without other options.
There can be disadvantages to filing for bankruptcy, without a doubt. Bankruptcy will have a negative impact on your credit. As a matter of fact, it can stay on your credit report for up to 10 years. However, it will not take 10 years to regain a good credit score or qualify for prime rate loans. Typically, after about two years, a person who has filed Chapter 7 bankruptcy can finance the purchase of a home with a good interest rate. In less time than that, it is possible to purchase a car with a reasonable interest rate.
What about the downsides to paying off debt using retirement funds or settling delinquent accounts? Though it may not seem logical, there are several:
Your credit will suffer if you have settled accounts that are not paid in full. The impact will not be as severe as a bankruptcy, however your credit will be heavily impacted from any delinquent payments prior to settling the debts.
You can be taxed on the amounts your creditors write off. This is called cancellation of debt income. The creditor can send you a 1099 at the end of the year for any amount that was written off. You may be required to claim that amount as additional income for tax purposes and pay more taxes as a result.
You may deplete an asset that you will need in the future. Retirement plans are completely protected from your creditors when you file bankruptcy. This is probably the asset that is most crucial to protect because it means security for your future. Unfortunately, we won't be able to rely on Social Security forever, so it is important to protect your savings in order to live comfortably in retirement.
While settling debt can be a good alternative to filing bankruptcy, it is important to know the consequences. Far too many people use their savings to try to get out of debt, only to find that they are not able to settle all of their outstanding accounts and end up filing bankruptcy in the end. Before proceeding in either direction, investigate your options and weigh the pros and cons in order to make an educated decision that is in your best interest.
• Denise K. Aguilar is a local attorney whose bankruptcy practice focuses on consumer and small business bankruptcy. She can be reached at (480) 455-1881. Additional information regarding the Aguilar Law Firm, P.C. is available at www.aguilarlawonline.com.