Will bankruptcy take out my 401(k) and retirement accounts?

Are 401(k)s and Retirement Accounts Exempt in Bankruptcy?

Yes. Whether you choose to file for Chapter 7 or Chapter 13 bankruptcy, you will very likely be able to keep your retirement. Bankruptcy law is rooted in public policy. The idea being that debt shouldn’t crush familes. People should have a chance to start over with out losing all of their property in the process. As a reflection of this idea, state legislatures, as well as the federal government, have enacted exemption laws. Exemption laws protect property from creditors and from the bankruptcy trustee.

There are a whole series of exemption laws, most of which are favorable to debtors, which address exempting retirement accounts in bankruptcy.

If your retirement account is exempt, you will still own the funds in that account when the bankruptcy is over. Examples of accounts which are typically exempt include:

• 401(k)s
• 403(b)s
• Traditional IRAs, Roth IRAs, SEP IRAs, SIMPLE IRAs
• Keoghs
• Profit Sharing Plans
• Defined-Benefit Plans
• Money Purchase Plans

This list is not exhaustive, and other forms of retirement plans may qualify as exempt. In most cases, all of the funds in your retirement account are protected, but there are a few exceptions. For example, an IRA retirement account is only exempt up to $1,245,475 per person.

What NOT to do with Your Retirement Account in Bankruptcy:

• DO NOT take money out of your retirement account. This effectively converts exempt property which is safe, to non-exempt property, which isn’t. Once money leaves your retirement account, it is no longer protected, it’s treated like regular cash. Hence, if someone takes money out of their 401(k), that money can now be taken by creditors.
• DO NOT use money from your retirement account to pay your debts.This is a common mistake. A well meaning family uses a 401(k) to pay down debt thinking they’ll avoid bankruptcy. When they end up having to file (which happens more than you might imagine), they kick themselves because they could have exempted their retirement and emerged from bankruptcy with their retirement intact.
• DO NOT deposit cash from your other accounts into your retirement account in an attempt to hinder creditors. If you convert your nonexempt assets (meaning things that you will lose in bankruptcy) into exempt assets, a bankruptcy judge may declare that moving these funds constitutes a fraud that is only designed to shortchange your creditors. If this happens, it is possible that your retirement account will lose its exempt status, and now you will even lose your 401(k) during bankruptcy.

What Are “Excluded” Retirement Plans?

In addition to those retirement plans that are exempt, some retirement plans are “excluded” in bankruptcy, meaning they are not part of the bankruptcy estate (see section 541(c)(2) of the Bankruptcy Code). As Cathy Moran points out in this article [1]:

“Nearly all pensions and 401K savings plans that are qualified under ERISA, the federal pension savings act, have an anti alienation clause that excludes them from the bankruptcy estate.”

These types excluded of accounts are simply not included in bankruptcy, and technically, there is no need to claim them as exempt. However, be aware of possible exceptions to the rule. To once again quote Cathy’s article:

“An exception to this rule is retirement plans that have only one participant, such as single employee corporate plans, and some other plans originating in self employment.  These plans may be property of the estate.  They may be vulnerable to creditors unless subject to an exemption.  Get good professional advice if this describes a significant asset of yours.”

Whether the retirement account is included in the bankruptcy estate or not, the practical effect is the same for most people. You keep the money in the retirement accounts, but still list them on your bankruptcy schedules. Bankruptcy schedules are the documents you must fill out that provide your financial information to the court. Examples of excluded retirement accounts include:

• Educational Individual Retirement Accounts (IRA) under IRC 530(1)(b)
• Pension and Retirement Plans that are qualified under the Employee Retirement Income Security Act (ERISA)
• IRC 414(d) Government Retirement Plans
• IRC 567 Deferred Compensation Plans
• IRC 403(b) Tax Deferred Annuity Plans

The excluded status of some of these retirement plans may come with some limitations. For a more thorough understanding of the status of your retirement plan, discuss the matter with a bankruptcy attorney.