What Happens to My 401(K) if I File For Bankruptcy?
In most cases, your retirement accounts
including a 401k are protected from your creditors in bankruptcy.
What Happens to
my Property in Bankruptcy?
Many people mistakenly believe that they will
have to give up almost all of their property if they file bankruptcy
relief.
While a Chapter 7 bankruptcy
trustee has the power to liquidate your nonexempt assets to pay back
creditors, state and federal laws provide exemptions that protect a certain
amount of your property in bankruptcy. Specifically, retirement accounts have
some of the broadest protections in bankruptcy.
Are 401k's Excluded Property in Bankruptcy?
401k and other retirement accounts that are
qualified under the Employee Retirement Income Security Act (ERISA) are
typically not part of your bankruptcy estate.
This means they can't be taken by the trustee to pay your
creditors. Most employer sponsored
retirement plans are ERISA qualified. But if you are considering filing for
bankruptcy, check with your employer to make sure your 401k is qualified.
The United States Supreme Court ruled that
ERISA qualified retirement plans are not property of the bankruptcy estate, and
cannot be taken from you by the trustee. Examples of ERISA qualified
retirement plans include:
- 401(k)s
- 403(b) or profit sharing plans
- 457(b) deferred compensation plans
- governmental plans, and
- tax exempt organizational retirement plans.
The major advantage is that these types of
plans are protected up to an unlimited amount – you don’t have to worry about
the trustee distributing any of these assets to your creditors.
Are Traditional and Roth IRA's Also Protected in Bankruptcy?
Federal bankruptcy law also protects non-ERISA
retirement accounts. Non-ERISA plans include:
- IRA’s
- Roth IRA’s
- SEP-IRA’s (for small business owners)
- SIMPLE IRA’s (for self-employed individuals), and
- similar retirement plans.
Unlike ERISA plans, the protection for
traditional and Roth IRAs is capped at $1,245,475. If you have more than
one traditional or Roth IRA, you can only protect $1,245,475 combined (not per
account). This means the bankruptcy trustee may be able to take any amount over
$1,245,475 in order to repay your creditors. This cap is adjusted every
three years for inflation, and was last adjusted in April 1, 2013.
The new bankruptcy law, however, did give
unlimited protection to SEP-IRAs and SIMPLE IRAs. That means that if you have a SEP-IRA or a SIMPLE IRA, the trustee cannot take any of it,
regardless of its value or amount.
When Is a Retirement
Account Not Protected?
Although your retirement accounts are generally
safe from your creditors when you file for bankruptcy, there are a few
exceptions.
- If you withdraw money from a retirement plan, it is no longer protected.
- These rules only apply if you file for bankruptcy.
- If the IRS has filed a valid tax lien against you, it may be able to reach your retirement assets.
- Divorcing spouses may have access to your retirement accounts.
This is just a high level overview of a complicated area of
law. If you are considering filing for
bankruptcy it is advisable to consult a bankruptcy attorney.
