How Bankruptcy Affects Retirement Assets

Do you worry about how bankruptcy affects retirement assets? Some assets are exempt from the terms of bankruptcy—they cannot be sold to satisfy creditors. Your retirement funds fall into this category and are safe from seizure by creditors and the bankruptcy court.

Your retirement funds are exempt from bankruptcy and safe from seizure by creditors and the bankruptcy court.

How Does Bankruptcy Affect My Pension Benefits?

In 2005 Congress overhauled the bankruptcy laws to protect qualified Employee Retirement Income Security Act (ERISA) retirement and pension funds. The overhaul of the original 1974 act provided protection to those accounts from creditors. A few exceptions exist; your individual state may have additional exemptions that apply to your accounts as well.

The best way to protect your retirement fund is to consult a bankruptcy attorney in your jurisdiction. The following ERISA-qualified retirement accounts are exempt from creditors in bankruptcy:

  • Any defined benefit plans
  • Keoghs
  • 403(b)
  • IRA
  • 401(k)
  • Profit sharing plans
  • Money purchase plans

IRAs and Roth IRAs have some limitations. The last adjustment in 2016 provided for an exemption of $1,283,025. Unless you have more than this amount, the bankruptcy court cannot touch your money. If your account exceeds the exempt amount, you may have to withdraw the excess to pay toward your debt.

Your 401(k) Is Exempt from Bankruptcy

Whether you file chapter 7 or chapter 13 bankruptcy, your 401(k) remains safe from creditors. Federal law specifically exempts 401(k) and other types of tax-exempt accounts from seizure by the bankruptcy court in chapter 7. Federal law protects all ERISA-qualified, tax-exempt, retirement accounts. Regardless of whether you use exemptions defined under federal or state bankruptcy laws, no cap exists to the exemption amount, with one exception. Traditional and Roth IRAs with a cap on amounts of money in the combined funds are exempt from seizure by the bankruptcy court. Because chapter 13 bankruptcy does not require relinquishing property, your tax-exempt retirement accounts remain safe.

Actions to Avoid

Since bankruptcy protects your 401(k) from creditors, you can file and not worry about losing your retirement assets. However, if you are considering bankruptcy, you want to avoid doing any of the following with your 401(k) or any other tax-exempt retirement accounts. Do not:

  • Make any withdrawals from your 401(k). Once you remove the funds from your 401(k) and deposit them into another account, they will no longer be exempt.
  • Use your 401(k) to try to manage your finances. In most cases this fails.
    • First, you will pay penalties for early withdrawal of your 401(k)
    • Second, you will use exempt assets when trying to pay off debts likely to be discharged when you do file bankruptcy later.
    • Third, it’s better to keep the 401(k) funds intact in the event you file bankruptcy later.
  • Avoid moving a substantial amount of money before filing bankruptcy
    • You make think it a good idea to convert your non-exempt assets into exempt assets. By investing a large amount of money into a retirement account not long before filing for bankruptcy, the trustee may view this as your way to avoid paying creditors.
      • The court may then remove the exempt status of your funds or worse, refuse to grant a bankruptcy discharge if they believe you committed fraud.
Bankruptcy Chart

How Does Bankruptcy Affect My Retirement Income?

Once you begin collecting income from any of your retirement accounts, those funds could be made available to creditors. If you failed to disclose a debt, or the court did not discharge a debt, a creditor may still legally require payment. When you file a chapter 7, the court discharges, with few exceptions, any debts you report. Creditors may no longer legally require repayment. If you file a chapter 13, the court determines how much you need to support yourself. All funds beyond those may be accessible to creditors until the bankruptcy concludes at the end of the repayment period. In a chapter 13, income you receive from any retirement plans will be included when the court determines the amount you can afford to pay your creditors.

Federal law does not allow creditors to attach Social Security payments or other government sources. However, the federal government does allow money to be paid from those checks before you receive them in the following instances:

  • Federal taxes
  • Debts to the federal government including student loans
  • Alimony and child support
  • Restitution to the victim of a crime as ordered by the court

Unfortunately, once the money arrives in your bank, it’s open season for creditors. However, a 2011 law, updated in 2013, requires banks to hold two months of payments before allowing creditors to seize funds. The same is true for ERISA-qualified retirement income (e.g., pension) deposited with your bank. They are also required to know whether the account includes federal benefits before allowing a seizure by creditors.

Conclusion

While most non-taxable retirement accounts are exempt from bankruptcy, exceptions exist. Both traditional IRAs and Roth IRAs cap the amount of exempt funds. The court may consider quickly moving money before bankruptcy from a savings account into a 401(k) or other non-taxable retirement account as fraud. As a result, the court may declare the funds non-exempt, or deny the bankruptcy.

Retirement income is generally exempt from bankruptcy prior to its issuance. However, once it arrives in your bank account, it may become accessible to creditors. In the case of Social Security or other government funds, the bank must protect two months of payments before releasing any money to creditors. To avoid trouble, seek the advice of a bankruptcy lawyer before you file to determine your rights and what you can expect.

Worried about how bankruptcy might affect your retirement accounts? Call Credit-Yogi for help.
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