Fortunately, whether you file a Chapter 7 or a Chapter 13 bankruptcy, in most circumstances you still get to keep your 401(k).
Chapter 7 Bankruptcy
In almost every Chapter 7 bankruptcy case, the person filing the bankruptcy gets to keep all of his or her property. However, in some cases a person has more property than he or she is allowed to keep. One of the types of property that presents the most challenges is retirement funds. Usually, in a Chapter 7 case, a retirement account is protected. However, certain retirement accounts are not protected, and can instead be seized and sold by the bankruptcy trustee in order to pay your creditors.
Retirement funds that qualify under the Employee Retirement Income Security Act (ERISA) are generally protected. 401(k) plans are usually ERISA qualified. However, even retirement plans that are not ERISA-qualified (such as, for example, IRA accounts) can potentially be exempt up to $1,362,800.
Chapter 13 Bankruptcy
In Chapter 13 you get to keep your property, so your 401(k), IRAs, and other tax-exempt retirement accounts are fully protected from creditors and bankruptcy trustees.
What If Your Retirement Accounts Are Used as Income?
Social Security payments are not considered income for purposes of bankruptcy and are not factored into the means test calculation. However, if you have other sources of retirement income, then those amounts will be evaluated along with your other income and expenses in the bankruptcy means test that could determine whether you are eligible for a Chapter 7 bankruptcy. And in a Chapter 13 case, retirement income is considered when creating a repayment plan.
What NOT to Do with Your Retirement Accounts
There are certain things you should avoid doing with your retirement accounts before filing for bankruptcy if you want to ensure that your assets remain protected.
Do not try to convert your nonexempt assets into exempt assets by making a large contribution to your retirement account before filing for bankruptcy. If the bankruptcy trustee has reason to believe that you transferred your assets in an attempt to interfere with the bankruptcy process or defraud a creditor, your property could lose its exempt status. If the bankruptcy court believes that you attempted or engaged in fraud, you could even be refused a bankruptcy discharge entirely.
You should not try to cash in your 401(k) or move the money out of your retirement account either. Once your money is moved from your 401(k) into another type of account (which could also incur hefty early withdrawal fees and tax penalties), those funds lose their exempt status. It may be tempting to use the money that has accumulated in your retirement account to help ease some of your debt, but you would likely be using your exempt assets to try to pay off debts that would ultimately be discharged at the end of the bankruptcy anyway.
When Could Your Retirement Assets Be Unprotected?
There are other situations where your retirement assets may NOT be protected. The most common include:
- If you owe federal income tax debt, the IRS may be able to reach your retirement assets;
- If you have outstanding criminal fines or penalties, your accounts may be seized by the federal government;
- If you are in the midst of a divorce, your ex-spouse may have access to your retirement accounts;
- If the retirement account was inherited it may be treated differently than an account that you funded yourself.