Exempting Retirement Funds in Chapter 13 Bankruptcy

Filing for bankruptcy can be a scary thing, but it doesn’t have to mean losing everything. When it comes to retirement funds like 401(k)s and IRAs, there are special protections in place to help you keep that money safe in bankruptcy. This article will explain how retirement accounts are treated in Chapter 13 bankruptcy so you can make the best decisions for your financial future.

The Basics of Chapter 13 Bankruptcy

First, a quick overview of Chapter 13 bankruptcy. This type of bankruptcy allows you to keep your assets like your home or car while repaying some of your debts over 3-5 years. The court approves a repayment plan where you make monthly payments to a trustee who then distributes the money to your creditors. At the end of the repayment plan, any remaining unsecured debt is discharged – meaning you are no longer legally required to pay it back.

This can be a great option if you have assets you want to keep but need some debt relief. Now let’s look at how retirement accounts fit into the picture.

Retirement Accounts Are Usually Protected

The good news is that your retirement savings are generally protected in Chapter 13 bankruptcy thanks to something called “exemptions.” Exemptions are laws that allow you to keep certain assets in bankruptcy. Here are some key things to know:

• Most retirement accounts like 401(k)s, 403(b)s, 457(b)s, IRAs, and pensions are fully exempt with no dollar limit.
• The exemptions come from federal bankruptcy law and your state’s exemptions.
• The most common retirement accounts can be fully exempted using the federal exemptions.
• Some state exemptions may protect other types of retirement accounts too.

This means in most cases, you can keep your retirement savings in full when filing Chapter 13 bankruptcy. Creditors cannot seize those funds to repay your debts.

Exceptions to Be Aware Of

While retirement funds are largely protected, there are some exceptions to be aware of:

• Tax liens – Retirement accounts are not exempt from IRS tax liens.
• Fraud – If you contributed to a retirement account in a fraudulent way right before bankruptcy, those funds may not be protected.
• High-value IRAs – IRAs above $1,283,025 (as of 2019) may not be fully exempt. The limit adjusts periodically for inflation.

It’s a good idea to speak with a bankruptcy attorney if you have any concerns about whether your retirement accounts may fall into these categories.

Should You Take Money Out of Retirement Accounts Before Filing?

You may be tempted to take money from your retirement account to pay off debts before filing. This is usually not a good idea for a few reasons:

• Money withdrawn will count as income and could disqualify you from Chapter 7 bankruptcy.
• In Chapter 13, withdrawn funds count as disposable income and you may have to pay more to creditors.
• You lose future tax-deferred growth and compounding on the money taken out.
• You may face tax penalties for early withdrawals if you are under age 59 1/2.

It’s best to leave retirement accounts intact if possible. Work with your attorney on other options to deal with debts pre-bankruptcy.

What About Ongoing Retirement Income in Chapter 13?

If you are already retired and receiving income like Social Security, pension payments, or 401(k) distributions, here is how that income is treated in Chapter 13:

• Social Security income is fully exempt and not included in repayment plans.
• Most pension income is exempt, but some courts limit the exemption to what is reasonably necessary for living expenses.
• IRA and 401(k) distributions may count as disposable income. Your attorney can advise if any portion can be exempted.

The trustee may ask for copies of statements showing retirement income received. Be sure to keep good records so you can accurately report this income.

How to Protect Retirement Funds in Chapter 13 Bankruptcy

Follow these tips to help keep your retirement funds safe through the bankruptcy process:

• Open a separate account for Social Security deposits to avoid commingling with other income.
• Avoid withdrawing from retirement accounts to pay debts prior to filing.
• Review if state exemptions offer more protection than federal exemptions.
• Be prepared to document details of retirement accounts – balances, statements, etc.
• List retirement accounts properly on your Schedule C bankruptcy forms.
• Inform your attorney of any concerns about possible exceptions.
• Closely review exemption amounts if you have high balances in accounts.

With some advanced planning, you can enter Chapter 13 bankruptcy feeling confident your nest egg remains protected.

The Bottom Line

Filing Chapter 13 bankruptcy does not have to mean jeopardizing your retirement funds. In most cases, accounts like 401(k)s and IRAs can be fully exempted from creditors. However, there are some exceptions and limitations to be aware of, so be sure to consult with an experienced bankruptcy attorney.

With proper advice, you can develop a bankruptcy strategy to eliminate debt, keep assets like your home, and preserve your hard-earned retirement savings. Don’t let fear of losing your nest egg stop you from exploring financial relief through Chapter 13 bankruptcy.