A recent article on the National Consumer Bankruptcy Website http://nacba2.memberpath.com/News/tabid/89/ID/607/Costly-Debt-Settlement-Schemes-Prey-on-the-Most-Debt-Burdened-Consumers-Struggling-to-Recover-from-Economic-Downturn.aspx noted that only one out of ten debt settlements worked to get consumers out of debt. If these numbers are not telling enough, they don’t account for the fact that Debt Settlement, even if successful, can cost you as much if not more than the original debt. One reason is that forgiven debt results in tax liability. For example, if you owe Capital One Bank $10,000 and they will accept $5,000 in satisfaction of the debt, you will end up with a 1099 showing income of $5,000, the amount of the debt forgiven. Assuming 30% federal and state taxes you have now saved only $3,500. If you are paying a debt consolidation company you may save even less. In addition, many people tap their 401k’s or IRA’s to pay down debt. Assume you take the $5,000 from your 401k, you pay $1,500 for the forgiven debt, you pay 1,500 for the withdrawn money and you pay a 10% penalty. The cost of settling the $5,000 debt equals $4,000. On the other hand, discharged debt, through bankruptcy, does not result in a taxable event. In addition, instead of effectively paying between $6,500 and $9,000 to settle a $10,000 debt, you pay only the filing and attorneys fees. Before you decide on your best option for getting out of debt, do the math. You might be surprised at what you find.
