We all know that as a result of the Coronavirus, the Stock Market is all over the place. We also know that the Stock Market will come back, eventually. So the question we are posing is, should you take the money out of your 401K, IRA, or other Qualified Retirement Plan to pay your ordinary household bills or your credit card debt or not?1
Consider the following hypothetical:
An average single person living in Essex County, New Jersey is earning $60,000 per year (W- 2 Income or 1099 Income). Let us assume that he is living in a modest one-bedroom apartment, has a reasonably priced car that is financed, drives to work, has a few thousand in his checking account and has a 401K through his employer valued (before the Corona Crash) of $25,000. Now during the Corona Crash, his 401K value has dropped seriously to $12,500, he still has his bills to pay. He has now learned that the Federal Government is going to help with a stimulus check, but he has three credit cards with a total of $12,000 in credit card debt2. Additional expenses are rent, food, utilities, car insurance, renter’s insurance, cell phone/cable and/or internet.
Let’s say he is in the 22% tax bracket3, so his $5,000 per month gross (and he is paid twice a month), after a health insurance premium deduction by his employer of $150 per check becomes $3,666 per month (or $1,833.00 net per check). He has to pay $1,500 in rent (so we are down to $2,400), and a car payment of $400. That means he has $1,766 per month to pay the rest of his utilities, expenses and food. According to the Internal Revenue Service, the average single person household utility bill in New Jersey is a total of $571.00, and according to the Internal Revenue Service, the average allowed expense allowed for food os about $400 per month. So that means that he has roughly $800.00 for his car insurance, AND to pay any of his bills.
The average minimum payment on a credit card is about $40.00, but if you try to just pay minimums the interest will kill you. Just take a look at your own credit card statement. You will see, if you only pay the minimum, it will take about ten years to pay off a $5,000 balance depending on the interest rate being charged. So let’s say our hypothetical person’s average payment is $100.00 per card and that means his auto insurance better be less than $400.00 per month, otherwise, he is out of money. Let’s not forget about any medications, doctors co-pay, or maybe going out for a movie and dinner. Our average person is out of cash, so he uses his credit cards, and the bills continue to increase, which also means the minimum payment will increase.
Since the Corona Virus hit, his 401k balance has been decreasing, so he thinks, let’s take it out. The problem is, he is under 59.5, so he will have a pay a penalty of 10%, plus he will have to pay tax on that money.
So is it wise to cash out, or should he consider a Chapter 7 Bankruptcy?
In New Jersey, as with many States, New Jersey follows the Federal Exemptions found at title 11 of the United States Code in Section 522. According to that specific statute, in subsection 12, “[r]etirement funds to the extent that those funds are in a fund or account that is exempt from taxation under section 401, 403, 408, 408A, 414, 457, or 501(a) of the Internal Revenue Code of 1986.” This means that if this person filed for bankruptcy, he would be relieved of his obligation on his bills, yet be able to keep his car, and keep what is in the retirement account (401K, IRA, SEP) without an issue. He would not have to pay the penalty, he would not have to pay the tax, and he is able to be relieved of the burdening debt. There are numerous other types of exemptions that are available to debtors for exempting out equity in property, household goods and furnishings, equity in a vehicle, jewelry and even a wildcard provision. All of these, when properly used, can shelter the important and necessary items in your life.
Bankruptcy is not always the best solution, just in this hypothetical situation. If you want to discuss your specific situation, feel free to contact the Law Office of Stuart M. Nachbar, P.C., at (973) 567-0954, or email via our website www.snanj.com. We are now handling initial matters (consults) via Zoom Media, Ring Central or just via the phone if you are more comfortable in that setting. We have the ability to send out a client question sheets and credit counseling via email. We offer a free no-cost consultation to every person who mentions this advertisement, and we are conveniently located on Eisenhower Parkway in Livingston, New Jersey. We handle Chapter 7 and Chapter 13 cases for all of Northern and Central New Jersey.
1. This is not an analysis related to a person who owns a home and is behind on the Mortgage Payments. Watch for a further article on that specific situation coming soon, which will also include a discussion on use of the Court’s Loan Modification Program.
2. It should be noted that the average credit card holder has at least four cards. On average, each household with a credit card carries $8,398 in credit card debt. This is according to www.debt.org. Total U.S. consumer debt is at $14.15 trillion dollars according to Center of Microeconomic data (part of the Federal Reserve Bank of New York Research and Statistics Group) as of the end of 2019. That includes mortgages, auto loans, credit cards and student loans.
|Tax rate||Single||Married, filing jointly according to the Internal Revenue Service|
|10%||$0 to $9,700||$0 to $19,400|
|12%||$9,701 to $39,475||$19,401 to $78,950|
|22%||$39,476 to $84,200||$78,951 to $168,400|
|24%||$84,201 to $160,725||$168,401 to $321,450|