Retirement Plans Under Bankruptcy Law
Both Chapter 7 and Chapter 13 bankruptcy generally will protect a debtor’s retirement plan, with some exceptions. Exemptions under federal laws and the laws of some states have protected funds in pension plans and ERISA-qualified retirement accounts since 2005. This means that you will not need to give up these funds if you liquidate your assets under Chapter 7, and you will not need to make higher monthly payments under a repayment plan in Chapter 13. However, you should be aware that different rules apply if you withdraw funds from a retirement account and place them in a different account with other funds.
Exemptions protect retirement accounts in their entirety, except for traditional IRAs and Roth IRAs (see below). Some examples of these accounts include a 401(k), a 403(b), a profit-sharing plan, or a money purchase plan. Money in investment accounts, savings accounts, and stock option plans will be covered by this type of exemption only if they qualify under ERISA, which may or may not be true. In some states, a debtor still can use an exemption to cover bank accounts and investment accounts, but the amount covered usually is not significant. Whether you file under Chapter 7 or Chapter 13, you will lose any money in these accounts that is not covered by an exemption.
Exemptions for Traditional IRAs and Roth IRAs
As of 2022, an exemption protects IRAs and Roth IRAs only if you hold $1,512,350 or less across all of your retirement plans. This is an overall exemption, rather than an exemption for each plan. If you have more than that amount in your plans, any surplus amount in a traditional or Roth IRA can be transferred to the bankruptcy trustee to pay to creditors. Federal law raises this amount every three years, so you should check the specific amount when you file.
Withdrawing Funds from Retirement Accounts
If you take money out of a retirement account, this will be considered income for bankruptcy purposes. If you are seeking to file under Chapter 7, this means that you may not be eligible under the means test. Assuming that you pass the means test and file under Chapter 7, these funds may be accessible to the bankruptcy trustee if you do not need them for your basic necessities. If you are filing under Chapter 13, by contrast, funds withdrawn from a retirement account may increase your monthly payments under your repayment plan. This is because they will be considered disposable income that can be put toward paying off your unsecured debts. Thus, you may want to refrain from withdrawing money from a retirement account until after you have completed the bankruptcy if possible. This may be just a few months if you file under Chapter 7.
Aging individuals who are considering withdrawing funds from retirement accounts often have very few other assets. As a result, they may be protected from collections efforts because they are judgment proof, meaning that there is nothing for a creditor to take. Bankruptcy may not be a worthwhile strategy for them if they remain judgment proof.
