Let me say first, I like Dave Ramsey. I enjoy his radio program and I find most of his advice to be a dose of common sense that people are all too often lacking. I even agree with Dave that Bankruptcy should be avoided id possible, but today I came across some advice Dave gave out that made me start yelling profanities at my computer screen. So what is this terrible awful no good advice that turned me into a red faced brute? This:
If Dave had just stopped after You never cash out a 401(k) or IRA to pay off debt, I would wholeheartedly agree. Why is cashing out a 401(k) or an IRA to pay off debt bad advice? Well, let’s let Dave himself answer that:
“Let’s say you take $50,000 out of your 401(k). Do you know what happens next? They’re going to charge you a 10 percent penalty, plus your tax rate. If you make $75,000 a year, that puts you in a 25 percent tax rate, plus the penalty. That’s a 35 percent hit, and that’s how much of your money is going straight down the toilet.”
So both Dave and I agree that taking money out of a retirement plan to pay off debt is a terrible idea, but why on earth does Dave think you should do it to avoid Bankruptcy? I wish I knew, there is no good reason. Let’s look at what a bankruptcy could do in a situati0on like this:
- Chapter 13 could stop a foreclosure and allow you to cure the arrears over time, AND let you keep your retirement savings.
- Chapter 13 could allow you to repay most or all of your debts in one payment, AND let you keep your retirement savings.
- Chapter 7 could eliminate most if not all of your debts, AND let you keep your retirement savings.
- Either Chapter 7 or Chapter 13 would allow you to continue saving for retirement and free up more money to do so.
I can understand Dave’s idea that you should do whatever it takes to repay your creditors, but this idea is irresponsible. If for not other reason that those retirement funds are there for a reason — FOR RETIREMENT! If people don’t have those funds when they retire, they become reliant upon the government or go further into debt, so I just don’t see how anyone would benefit in that scenario.
Cashing out a retirement plan is not a solution, it is a stop gap measure. You are trading one creditor for another, because you may get Visa or MasterCard off your back, but the IRS will take their place. I don’t know about you, but I’d rather deal with Visa than the IRS. More often than not, people who cash out retirement plans still end up filing bankruptcy, except now they don’t have any retirement savings.
Obviously Dave Ramsey is a successful guy who has made a career out of giving financial advice, but that doesn’t mean it is always good advice. Dave himself went through bankruptcy and it helped to set him up for future success, and it very well could do the same for you. If you are thinking of taking money our of your IRA or 401(k) to avoid bankruptcy, you owe it to yourself to talk to a competent bankruptcy attorney first.