Strategies for Preserving Retirement Income in Bankruptcy

Strategies for Preserving Retirement Income in Bankruptcy

Filing for bankruptcy can be a difficult decision, especially when retirement is on the horizon. Many people worry about losing their retirement savings and income in bankruptcy. However, there are strategies you can use to protect your retirement funds and income when filing for bankruptcy. This article will discuss those strategies, the applicable laws, and how to navigate the bankruptcy process to preserve your retirement.

Overview of Bankruptcy and Retirement Accounts

When you file for bankruptcy, most of your debts will be discharged – meaning they are eliminated. This includes unsecured debts like credit cards, medical bills, personal loans etc. Your retirement accounts like 401(k)s and IRAs are usually protected in bankruptcy. This allows you to get rid of debt but keep your retirement savings.

There are two main types of consumer bankruptcy:

• Chapter 7 – This is known as “liquidation” bankruptcy. Your nonexempt assets are sold to pay creditors. Most retirement accounts are exempt and you get to keep the funds.
• Chapter 13 – This is “reorganization” bankruptcy. You keep your assets but must repay some debts over 3-5 years from disposable income. Retirement account funds are usually protected.

The main laws governing retirement accounts in bankruptcy are:

• ERISA – Protects employer-sponsored plans like 401(k)s. These have unlimited protection in bankruptcy.
• Federal and state exemptions – Allow you to exempt and protect IRAs and certain amounts in other retirement accounts.

The strategies discussed below utilize these laws to maximize retirement account protection. Having an experienced bankruptcy attorney assist you is highly recommended.

Strategies to Protect Retirement Funds in Chapter 7

Chapter 7 bankruptcy provides the most protection for retirement accounts. Strategies include:

Fully Exempt Retirement Accounts

• 401(k), 403(b), pension, TSP – These qualify for unlimited exemption under ERISA. The full account balance is protected.
• Traditional and Roth IRAs – Up to $1 million is exempt for each spouse under federal bankruptcy law. State exemptions may protect more.
• 457(b) plans – These are exempt under federal law if set up by a governmental employer.

The best strategy is to fully fund these accounts prior to bankruptcy to maximize exemption amounts. Be aware that recent large contributions could be challenged as fraudulent transfers[1].

Roll Over Lump Sums to Protected Accounts

If you have a lump sum pension/401(k) distribution or non-exempt retirement account, consider rolling it over to a protected account like an IRA before filing. This shields the funds from creditors[2].

Avoid Cashing Out Accounts

Liquidating retirement accounts to pay debts prior to bankruptcy will backfire. Those funds will become nonexempt assets the trustee can seize. Leave the money in the protected accounts.

List Accounts Properly on Your Bankruptcy Schedules

Be sure to list all retirement accounts on your exemption schedule and cite the exact laws that protect them. This prevents the trustee from wrongfully taking possession.

Strategies for Protecting Retirement Income in Chapter 13

In Chapter 13 bankruptcy, you must repay some debts from disposable income. Strategies to protect retirement income include:

Exclude Social Security, Pensions and Disability Income

These sources are excluded from the income calculation used to determine your repayment plan. This helps lower your payment amount[3].

Object to Improper Inclusion of Retirement Income

If the trustee tries to pull IRA/401(k) withdrawals or pension payments into the income calculation, your attorney can object and get it removed. This further minimizes the payment.

Make Voluntary Repayments from Exempt Income

You have the option to make additional voluntary payments using Social Security or other exempt retirement income. This helps you repay debt faster without raising the base plan payment.

Seek Permission Before Making Retirement Account Withdrawals

Notify the bankruptcy trustee if you need to take retirement account withdrawals for living expenses. Get approval first to avoid issues.

Delay Retirement Account Withdrawals If Possible

Try to leave accounts intact during your repayment plan. Taking withdrawals means losing creditor protection and exposes the funds to repayment claims.

Contribute to Exempt Retirement Accounts

Continue contributing to 401(k)s and IRAs during the plan – this shelters part of your income from creditors. Just disclose the contributions properly.

Other Strategies to Preserve Retirement in Bankruptcy

Some additional tips for protecting retirement through bankruptcy:

• Hire an experienced bankruptcy attorney, their expertise is invaluable.
• Consider alternatives like debt consolidation or settlement if you want to avoid bankruptcy altogether[4].
• If married, make sure accounts are evenly split and all are fully exempted. File individually if needed.
• Keep good records of all retirement accounts and be thorough in listing them.
• Research all applicable federal and state retirement exemptions that apply to you.
• Avoid moving assets around before filing, as it can trigger fraudulent transfer claims.
• Disclose all material information properly on your bankruptcy petitions and schedules.
• Realize Chapter 7 provides the most retirement account protection, but Chapter 13 may allow you to keep nonexempt assets like a house.
• Understand how retirement income impacts your repayment plan in Chapter 13, and take steps to minimize it.
• Consider continuing retirement contributions during and after bankruptcy to rebuild savings faster.