How Does Bankruptcy Affect Retirement Planning?

Whenever someone finds themselves in financial trouble and they consider whether to file for bankruptcy, it is not uncommon for them to be concerned about losing their assets.  One particular concern is whether, upon filing for bankruptcy, they will be able to retain their various retirement benefits.  Once you have worked for years to obtain these hard-earned benefits, it would be upsetting to lose them in a bankruptcy proceeding.  So, how does bankruptcy affect retirement planning?

Should I cash out my retirement before filing for bankruptcy?

No.  Generally, cashing out your retirement account prior to filing for bankruptcy is not a good idea. Retirement accounts enjoy broad protection from creditors in bankruptcy because they are normally either exempt or excluded from the bankruptcy estate altogether. Not to mention the severe penalties and negative tax consequences of cashing out your retirement account early.  Unfortunately, many debtors believe that they will have to forfeit most of their property if they file for bankruptcy relief. But, the reality is, retirement accounts have some of the broadest protections in bankruptcy.

Qualified retirement plans may be exempt

In many cases, debtors who find themselves in bankruptcy are allowed to keep certain retirement benefits, if those benefits are “qualified.”  The United States Bankruptcy Code defines a “qualified retirement plan” as follows:

any money or assets, payable to a participant or beneficiary from, or any interest of any participant or beneficiary in, a retirement plan or profit-sharing plan that is qualified under Section 401(a), 403(a), 403(b), 408, 408A or 409 of the Internal Revenue Code of 1986, as amended, except as provided in this paragraph.

What does that mean?  Well, the most common “qualified retirement plan” include profit sharing plans (including 401(k) plans), defined benefit plans, and money purchase pension plans. In general, plans in which your contributions are not taxed until you withdraw money from the plan.

ERISA Protections for 401(k) contributions

A bankruptcy trustee cannot take any of your 401(k) contributions because they are protected from creditors by ERISA (the Employee Retirement Income Security Act).  This protection is available only if the 401(k) account is still intact, meaning that no money has been removed from the 401(k) account and put into an unprotected account, such as a checking or savings account.  Once that happens, protection from the Trustee is gone.  The trustee is then able to access the funds and disperse them to creditors through the bankruptcy proceedings.

Other retirement accounts that are protected

There are certain annuities, available to particular organizations and non-profit entities, known as 403(b) retirement plans.  They are similar to 401(k)s and allow employees to make tax exempt contributions until withdrawals are made.  These annuities are protected from bankruptcy.  Roth IRAs and 457 plans are also generally exempt.  The 457 plan is a non-qualified tax advantaged deferred-compensation retirement plan, available to governmental and certain non-governmental employers in the United States.  These retirement plans are protected because they include restrictions on when and how funds from these plans can be withdrawn.

There are usually limits on the age of the person and fees to withdraw from these accounts, as well as tax implications at the time of withdrawal.  Being able to keep these assets allows for debtors to plan for the future and withdraw from these accounts when they reach a certain age and/or retire so they have some form of income at that time.

If you have questions regarding bankruptcy and retirement accounts, or any other retirement planning needs, please contact Wilcox Attorneys, PA online or by calling us at (479) 443-0062.