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

Many people work hard for decades to build up their retirement accounts, 401(k)s, and IRAs. If you’re considering a Chapter 7 bankruptcy, you may wonder what happens to these assets. The same is true if you’re filing a Chapter 13 bankruptcy case.

Generally, the courts protect your 401(k) or IRA retirement accounts from bankruptcy. Unless there are unusual or extreme circumstances, your retirement funds are not part of your bankruptcy estate. Generally, the U.S. Bankruptcy Courts will not expect or force you to drain your retirement funds in your efforts toward debt relief.

Here, we’ll explain what happens to your retirement savings if you file for bankruptcy. We will also briefly explain how bankruptcy can impact your retirement accounts, such as IRAs, pensions, and 401(k)s.

The Downside to Using Retirement Funds in Bankruptcy

Some think it’s worth using their retirement money to pay down their debt rather than file bankruptcy. The problem is that you may still be in debt even after draining your retirement accounts.

You must also consider that withdrawing retirement money may carry penalties, such as:

• Tax penalties if you are under age 66.2-67
• Income tax (average of 22% tax rate)
• Early withdrawal fees (usually a 10% penalty)
• Losing company matches from your retirement plan
• Losing interest over time
• Losing protection of inherited IRAs
• If you withdraw funds from your retirement account to buy other property or simply deposit them in a bank account, you could lose the special protections of retirement accounts.

The good news is that bankruptcy laws consider your retirement account "protected assets." You can file bankruptcy without impacting your retirement accounts.

Protected Assets vs. Unprotected Assets

There are two types of assets under bankruptcy: protected and unprotected. Protected assets are safe from liquidation due to state and wildcard exemptions.

The court can liquidate your assets in a Chapter 7 bankruptcy. In a Chapter 13 bankruptcy, the judge may order you to pay for the asset via a repayment plan.

Protected assets 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, many assets remain vulnerable to liquidation in bankruptcy. For example, the court can order the liquidation of your savings accounts, investments, and stock option plans. These are not ERISA-qualified accounts and can be used to pay off debts. The bankruptcy trustee can also seize these assets to pay off creditors.

Limits on Traditional IRA and Roth IRA

The law limits how much retirement money you can keep in bankruptcy. According to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), bankruptcy debtors can only keep a specific amount in retirement monies. The cap changes every three years based on the inflation rate.

Between April 1, 2022, and March 31, 2025, the cap on traditional IRAs and Roth IRAs is $1,512,350. This is the total amount protected in bankruptcy. So, if you have multiple accounts, the total amount safe in bankruptcy is still $1,512,350.

Most people don’t have this much in their retirement accounts, so it’s not an issue for their bankruptcy filing.

Using Retirement Accounts to Pay One Creditor

You can withdraw money from your retirement account to pay a debt you owe to a single creditor. You must do this before filing for bankruptcy in Chapter 7, and you can only do this for one creditor.

Before you do this, you should talk to a skilled bankruptcy lawyer. You do not need to tap into your retirement because of an aggressive creditor, and in most cases, you shouldn’t. It may seem like an honorable thing to do. But if you must file bankruptcy anyway, why surrender your retirement funds in vain?

In some situations, using retirement money to pay off a particular debt makes sense. For example, if you want to keep your vehicle post-bankruptcy, you may want to sacrifice some (or all) of your retirement savings.

You may also want to use this money to pay off a friend or family member. You don’t want to sour an important relationship by including a personal debt in your bankruptcy petition.

Using retirement money to pay off a creditor may cause problems with your bankruptcy case. The trustee or judge may deem it a preferential transfer. Another creditor may complain to the court that you paid off another creditor but paid them nothing.

If this happens, the trustee can void your payment. Trustees can void a transfer within 90 days (sometimes even up to two years) before you file for bankruptcy. Instead, they’ll take your money and liquid assets and use them to pay off all creditors of the bankruptcy estate on a pro-rated basis.

Filing for Bankruptcy After Retirement

If you already use your retirement accounts and receive retirement income, bankruptcy will affect you differently. Depending on which chapter you file, this income can impact the Chapter 7 Means Test and your Chapter 13 repayment plan.

If you’re retired and getting Social Security benefits, it shouldn’t be a problem. The bankruptcy courts do not consider Social Security income reachable by your creditors.

Bankruptcy Lawyers Can Simplify These Topics

The federal laws and the Bankruptcy Code can be confusing. Plus, the rules from state to state change constantly. Discussing your potential bankruptcy case with an attorney before you file your bankruptcy petition is a good idea.

Your bankruptcy attorney can review your bank accounts, retirement plans, and federal bankruptcy exemptions before filing bankruptcy. You can sit down with a bankruptcy lawyer and plan your fresh start and journey toward debt relief.