Is Your 401(k) or IRA Protected in Bankruptcy?

Yes, your 401(k) or IRA retirement accounts are protected from bankruptcy. Unless there are unusual or extreme circumstances, your retirement funds are not part of your "bankruptcy estate." You will not be expected or forced to drain your retirement funds to get debt relief.

The Downside to Using Retirement Funds in Bankruptcy

It may be tempting to reduce your total debt before you file bankruptcy. However, taking retirement money out early comes with penalties, such as:

• Tax penalties if you are under age 66.2-67 (depending on the year you were born)
• Income tax (this number can vary state to state but is often around a 22% tax rate)
• Early withdrawal fees (usually a 10% penalty)
• Losing company matches from your retirement plan
• Losing interest over time
• The account can lose its bankruptcy protection and be used to pay off debts

Your retirement account is considered a "protected asset" under the U.S. Bankruptcy Code.

Protected Assets vs. Unprotected Assets

Protected assets are safe from bankruptcy due to state exemptions, wildcard exemptions, or the amount of money you are allowed to keep in bankruptcy. Unprotected assets can be sold in a Chapter 7 bankruptcy, or paid for under a debt repayment plan in Chapter 13 bankruptcy.

The types of funds that are protected include:

• Employee Retirement Income Security Act (ERISA) plans (sometimes called ERISA pension plans)
• 401(k)s
• 403(b)s
• Roth IRAs, SEP IRAs, and SIMPLE IRAs
• Profit-sharing plans
• Defined benefit plans

Unfortunately, your savings account, investments, and stock option plans are not protected accounts. These are not ERISA-qualified accounts and can be used for debt relief or seized by your bankruptcy trustee.

There is a limit to how much retirement money you can keep in bankruptcy. As of the last publish date of this article, the limit is $1,283,025 total per person, so this considers all your accounts and retirement funds combined. Most people do not have this much in their retirement accounts, so it is not an issue for their bankruptcy filing.

Retirement accounts are protected assets. They cannot be taken by bankruptcy trustees and used for debt relief or to pay back creditors. While you can still choose to use your retirement funds when you file for bankruptcy, you will not be forced to do so.

Using Retirement Accounts to Pay One Creditor

You do have the option to withdraw from your retirement account to pay down debt to just one creditor. This must be done before filing Chapter 7 bankruptcy and can only be used for one creditor.

But before you put your financial future — and your retirement — at risk, talk to a bankruptcy lawyer. You do not need to tap into your retirement because of an aggressive creditor, and in most cases, you shouldn't.

So when does it make sense? It can be handy to finish off a car loan, or to stop a debt lawsuit. It can also be used to pay back personal loans to a friend or family member before you file for bankruptcy. (After you file, the debts are discharged, and they may not get their money back until you can make the payment in the future.)

Unfortunately, because you are picking and choosing between creditors, this might be considered a preferential transfer. It can be voided by your trustee — who can take the money into your bankruptcy estate and distribute it among all your creditors.

Some trustees can void a transfer within 90 days (sometimes even up to two years) before you file for bankruptcy. It will depend on your state, when you file, what Chapter you file for, and the bankruptcy trustee in your case.

Filing for Bankruptcy After Retirement

If you are already using your retirement accounts and receiving retirement income, then bankruptcy will affect you differently. Depending on which Chapter you file, you should consider your total income between your retirement income and funds when it comes to:

• The Chapter 7 Means Test
• The monthly payments for a Chapter 13 repayment plan

You can still qualify for either of these bankruptcies even if you are retired. Keep in mind your Social Security benefits are not income, and do not play a part in either type of bankruptcy.

Bankruptcy Lawyers Can Simplify These Topics

The federal laws in the Bankruptcy Code are confusing, and the rules also change state-by-state. You can discuss your bank accounts, retirement plans, federal bankruptcy exemptions, and more before ever filing bankruptcy. A free evaluation with an attorney can help set yourself up for a fresh start as you start your debt-relief journey.