Tag Archive for: Bankruptcy and Your Retirement Savings

Bankruptcy and Your Retirement Savings: What You Need to Know

Facing financial ruin is incredibly stressful. If you are being contacted by creditors, are at risk of losing your house, or have had a lawsuit filed against you to collect on a debt, you should be thinking seriously about your options. One way to seek a clean slate is to file for bankruptcy. 

While bankruptcy has some consequences, it can also help you to gain your financial footing. If you’re thinking seriously about filing for bankruptcy, it’s important that you understand the impact that bankruptcy can have on your finances, including your retirement savings. Here’s what you should know about bankruptcy and your retirement savings—to learn more, it’s recommended that you contact a financial or legal professional.

Using Retirement Funds for Debt

When thinking about your financial options when facing bankruptcy, you may think about withdrawing funds from your retirement accounts in order to help pay down some of your bills. While this could help you to stave off creditors and alleviate your debt, remember that withdrawing retirement funds can have consequences. 

Withdrawing retirement funds before reaching retirement age can result in hefty tax penalties, which could only exacerbate your financial dilemmas. Unless withdrawing retirement funds is your only option—and even then, you should seek professional advice first—keeping funds within your retirement accounts is almost always the best thing to do.

What Happens to My Retirement Funds During Bankruptcy?

Whether you are filing for a Chapter 7 or a Chapter 13 bankruptcy, the good news is that in most cases, you’ll likely get to hold on to your retirement or/and pension funds. However, there are some exceptions to this general rule. 

When you file for bankruptcy, regardless of whether you file for a Chapter 7 or Chapter 13 bankruptcy, you get to keep exempt assets. (Other, non-exempt assets are liquidated and used to pay back creditors.) In fact, under the federal tax code, all types of individual retirement accounts (IRAs) are substantially protected from creditors during a bankruptcy filing, as are pension plans, 401(k)s, and other employer-sponsored qualified retirement plans. 

How Much Is Protected During Bankruptcy?

For ERISA-qualified retirement accounts, which stands for Employee Retirement Income Security Act, the retirement account cannot be taken from you by the bankruptcy trustee appointed to your case. ERISA plans are inclusive of 401(k)s, 403(b)s, 457(b)s, governmental plans, and plans offered to employees by tax-exempt organizations. Bankruptcy law also protects IRAs, including traditional IRAs, Roth IRAs, SEP-IRAs, SIMPLE IRAs, and other similar retirement plans. 

If you file for bankruptcy, you can protect up to $1,512,350 held in your IRA. Note that if you have more than one IRA, the $1.5 million threshold doesn’t apply to both accounts individually, but is the combined amount you can protect. 

Are There Any Retirement Savings that Aren’t Protected in a Bankruptcy Filing?

As explained above, you cannot protect amounts over $1,512,350 (adjusted for inflation every three years) in a bankruptcy filing. What’s more, if you have other forms of savings that you plan to use for retirement, these funds will likely not be protected in a bankruptcy filing. You won’t be able to protect:

  • Any funds withdrawn from a tax-benefited retirement account
  • Funds held in a savings account
  • Money held in an investment account
  • Stock option plans

Should I File for Bankruptcy?

If you’re thinking about filing for bankruptcy, it’s important that you understand all of your options and the consequences associated with a bankruptcy filing. In most cases, filing for bankruptcy is a last-case resort that should only be pursued once other options have been exhausted. Other options that should be explored first include debt consolidation, refinancing, and credit negotiation.

If you do decide to file for bankruptcy, note that any savings that you hold in tax-advantaged retirement accounts will likely be protected, up to a certain threshold. This should provide some peace of mind in the event that you file.

Working with a Professional Is Always a Good Idea

Deciding to file for bankruptcy is a big decision and one that you likely shouldn’t make on your own if you’re not a financial professional. When you consult with a financial professional or/and a bankruptcy attorney, you can learn more about the process, the risks, the benefits, and how to get started. A professional can answer your tough questions about bankruptcy, help you know which type of bankruptcy you’re eligible to file for and advise you on asset protection throughout the process.