John has always dreamed of owning his own ice cream shop: Homemade cookie dough, cake batter, vanilla and chocolate would be the flavors of the day.
For years, he puts the dream off. First it is college, then it is business school, and then it is his boring, desk job.
But one day, he quits his job and sets out to be his own boss by finally buying that ice cream shop. He doesn’t have the money to buy the shop outright, which costs $200,000. So, he cashes out his IRA, worth $75,000, to use it as a down payment. John also agrees to pay back the seller the rest of the purchase price of $125,000 over a period of time.
Fast forward to one year later: A large, ice cream retailer comes into town and drives John out of business. John loses the ice cream shop because he can’t make the payments to the seller. John also can’t recover any of his down payment because the shop is “under water” or worth less than what John owes.
John’s story is a very sad one. Like John, you probably also have a pension of some kind, whether it be a 401k or an IRA or something else. But what you may not know is that most pensions are protected or “exempt” from judgment creditors outside of bankruptcy. Most pensions are also protected inside of bankruptcy. This means that most creditors can’t ever get to your pension to get their money.
By moving pension money into your business or investment, you are taking an asset that probably would have been protected from most creditors, i.e. the pension, and probably turning it into something that most creditors can probably now go after. This is because businesses or investments do not usually receive any protection from creditors. (What you can protect from creditors inside and outside of bankruptcy really depends on the exemptions available to you. For more information on which exemptions you are going to be using, see my guide titled “What’s Protected from Creditors - Inside & Outside of Bankruptcy” at www.olgazlotnik law.com).
Also, if the business or investment fails, then the pension money you put in it may not be recoverable. In John’s example, John lost the ice cream shop because he couldn’t make the payments to the seller and also lost the $75,000 down payment, which came from his pension. Had John kept the money in his IRA, the $75,000 would have been protected from most of his creditors, including the seller of the ice cream shop.
You may be saying, “But what if I can’t make ends meet and need to use money in my pension to live off of?” Well, if you are considering taking money out of our pension to make ends meet, then I would suggest you talk to a bankruptcy attorney before you withdraw pension money, and a tax professional to learn about the tax ramifications of a withdrawal. You may end up using funds from your pension to pay bills and then filing for bankruptcy anyway. You could have saved the pension had you consulted with an attorney early in the game. Trusted advice from a local bankruptcy attorney can help you avoid losing your pension unnecessarily.
The information provided here should be used for informational purposes only and does not constitute legal advice or create an attorney-client relationship with anyone. Olga is a graduate of Payson High School (Class of 2000) and founding attorney of the Law Office of Olga Zlotnik, Esq., a locally grown firm specializing in bankruptcy, debt and civil litigation issues. For more information, visit www.olgazlotniklaw.com or call (928) 978-2896.