Can Creditors Take Your 401(k) or IRA in Bankruptcy?

If you’re struggling with debt and considering filing for bankruptcy, you may be worried about losing your retirement savings. After all, the main purpose of bankruptcy is to use your assets to pay back what you owe. But here’s some good news – your retirement accounts are almost always completely protected in bankruptcy!

I know it can be tempting to take money out of your 401(k) or IRA when you’re in financial trouble. But try to avoid doing that if you can, because keeping your retirement funds intact will put you in a much better position when you get through bankruptcy.

401(k) and IRA Accounts Are Usually Fully Protected

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 protects tax-advantaged retirement accounts like 401(k)s and IRAs from creditors in bankruptcy. This means the trustee can’t force you to liquidate your 401(k) or IRA to pay back debt (with a few exceptions I’ll explain later).

This protection applies to most types of retirement accounts, including:

• 401(k) plans
• 403(b) plans
• 457 plans
• Traditional IRAs
• Roth IRAs
• SIMPLE IRAs
• SEP IRAs
• Keogh plans
• Pension plans
• Profit sharing plans

Accounts like these are protected whether you file Chapter 7 or Chapter 13 bankruptcy. That means the trustee can’t force you to withdraw money from the account to pay back creditors.

Why Are Retirement Accounts Protected in Bankruptcy?

There are a few reasons why the government protects retirement accounts in bankruptcy:

• To prevent people from becoming destitute in retirement if they lose their savings
• To align with public policy that encourages retirement saving
• To avoid people having to rely on government benefits if they lose retirement funds

The idea is that even if you file bankruptcy, you should be able to keep your nest egg intact so you have some income in your later years.

When Retirement Accounts Aren’t Fully Protected

Although 401(k)s and IRAs receive strong protection in bankruptcy, there are a few exceptions where your accounts could be at risk:

Unpaid Income Taxes

If you owe unpaid income taxes and penalties to the IRS, they may be able to seize part of your retirement savings to cover the tax debt. This could include taking up to 25% of your 401(k) or IRA.[5]

Qualified Domestic Relations Orders

If you owe child support, alimony, or marital property division payments to an ex-spouse, their claim to your retirement funds will supersede bankruptcy protection. The court could force you to pay your ex from your 401(k) or IRA under a qualified domestic relations order.

Fraud

If you are convicted of felony fraud, such as investment fraud or bankruptcy fraud, the court could potentially order repayment from your retirement account.

Should You Borrow or Withdraw From Retirement Accounts Before Bankruptcy?

You may be tempted to take loans or withdrawals from your 401(k) or IRA to pay off debts before filing bankruptcy. This is usually not a good idea:

• You may lose bankruptcy protection – Taking retirement money just to pay one creditor can be seen as preferential treatment, especially right before filing.
• You’ll miss out on future growth – The amount you withdraw today could substantially grow if left invested.
• You may face taxes and penalties – You’ll likely pay income tax on withdrawals plus a 10% early withdrawal penalty if you’re under age 59 1/2.

Consult with a bankruptcy attorney before making any 401(k) or IRA transactions leading up to filing.

What If You Already Withdrew From Your 401(k) or IRA?

Let’s say you already took money from your retirement account hoping bankruptcy would erase what you owe. Here are a couple things to know:

• Exemptions may still apply – Money already withdrawn from a retirement account typically loses its bankruptcy protection. But some states still exempt a certain amount of retirement assets.
• The trustee may retrieve recent withdrawals – If you withdrew a significant amount shortly before filing, the trustee may try to reclaim it to pay creditors.

Be up front with your attorney about any retirement account withdrawals so they can give you the best advice.

Keep Your Retirement Intact Through Bankruptcy

The bottom line is that your 401(k), IRA, and other retirement accounts are almost always completely protected if you file for bankruptcy. The bankruptcy system understands that losing your nest egg could leave you financially devastated for decades.

Do your best to avoid tapping retirement funds as you approach bankruptcy. With luck, you’ll get through the process with your 401(k) or IRA intact so you can start rebuilding for the future.