Think twice before dipping into your 401(k) to pay debt

People struggling with debt may turn to avenues such as taking on a second job or bringing in a renter to help with the bills. Sometimes, these approaches pay off. Other times, though, they can be risky or unnecessary. For example, an improperly vetted renter could cause significant property damage.

Similarly, if you are considering using funds from your 401(k) to pay down debt, that could be a mistake. Here is why.

Retirement plans are protected

Pension plans and 401(k)s are protected assets under bankruptcy laws to a wide degree. In Michigan, you can keep $1.1 million in your retirement savings. The main reason for this is that government officials recognize the importance of a fresh start. People need as many tools as possible to help them start anew after a bankruptcy and to stay in good financial health, even through retirement. If you have nothing at all, then you may well get stuck in a loop of debt.

On the other hand, if you are able to retain your retirement plan, then that money continues accumulating and, hopefully, keeps you afloat in retirement. Say you are 40 years old now and have been contributing about $5,000 yearly in your retirement plan since you were 25. If you stay on that track, you could be a millionaire by the time you retire. By using your retirement funds now to pay down debt, you open yourself up to losing tremendous long-term income and to paying upfront taxes and fees.

Bankruptcy means you keep your retirement plans and likely get a lot of debt discharged

Say you stay out of your retirement plans and file for bankruptcy. You should be able to get a lot, if not all, unsecured debt discharged or reorganized, and your retirement money is as intact as it has ever been. It keeps growing to serve you well when you need it.

Of course, not all debts are unsecured. It can be a good idea to meet with a lawyer to determine your options.