Why Using Up Your 401k Before Filing Bankruptcy is a Mistake

One of an individual’s greatest financial assets and sources of security is their retirement account, but some believe they must surrender that account if they file for bankruptcy. Chapter 7 bankruptcy does require filers to liquidate some of their assets. Does a 401k fit into that category? And will such an IRA survive chapter 13 bankruptcy? Those are important questions for preserving a financial future even after current economic difficulties are resolved.

Exempt IRAs

There are a number of individual retirement accounts that are exempt under both of the common bankruptcy plans today. Most plans covered by the Employment Retirement Income Security Act (ERISA) are protected in either of these petitions. The most common IRAs included in this protection are:

401ks

403bs

IRAs – including Roth, SEP, and SIMPLE

Keoghs

Profit-sharing plans

Money purchase plans

Defined-benefit plans

The primary exceptions to these exemptions are traditional and Roth IRAs valued at more than $1,095,000 per person.

That means that someone who holds one of these retirement plans can count on it being protected through either type of bankruptcy petition. However, if they cash out those plans, either partially or completely, those monies are not protected and will generally be used to pay creditors.

Other Retirement Income

There are other types of income from retirement accounts that may not be as protected as those balances. In those cases, the holder should carefully investigate their options before taking any action to be sure they are not jeopardizing their financial status further.

Some examples of monies that may not be protected when filing bankruptcy include:

Withdrawals from IRAs. These are treated as loans from the IRA to the IRA holder and cannot be discharged (erased) under chapter 7 bankruptcy. However, in chapter 13 bankruptcy, these loans might be discharged, or cancelled, depending on other circumstances of the filing, the debtor’s creditors, and the decision of the bankruptcy trustee. Even if they are discharged, those monies may be required to be directed toward other bill payments in the bankruptcy order.

Voluntary wage deductions for IRAs. Since these are voluntary payments, the court does not recognize them a necessities of life. They require filers to use their disposable income to pay creditors, not continue to fund their IRA. These payments will generally be discontinued during bankruptcy petitions. The only exception is generally in the case of a debtor nearing retirement age. The court may consider those funds necessary for their future financial security.

Getting Legal Help with Protecting 401ks in Bankruptcy

Not only is bankruptcy a complicated legal process, so is staying within the legal requirements of maintaining a tax-exempt IRA. Filers who wish to gain the most benefit from filing for bankruptcy, should contact a bankruptcy attorney before they ever begin. That way they can avoid the pitfalls that are causing so many people to remain in debt trouble even after completing the bankruptcy process.

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