Can Bankruptcy Touch Your Retirement Accounts?

Recently, a U.S. Bankruptcy Court of the Central District of California overruled a Chapter 7 trustee’s objection to a woman’s exemption claim to a $2 million dollar pension she inherited from her father. In a Chapter 7 bankruptcy, any nonexempt assets are liquidated by the trustee in order to pay creditors back. Anything deemed “exempt” under state or federal law is not included in the bankruptcy estate and thus is not allowed to be sold by the trustee.

This brings up a common question as to how retirement accounts are handled in a bankruptcy case. There are many options for retirement accounts such as 401(k) accounts, pension and profit-sharing plans, and IRAs to name just a few. California residents may have protections for some, while others are more vulnerable to judgment collections and Chapter 7 liquidation. Two of the most widely used retirement accounts in California are pensions and IRAs, and the distinction between the two, when it comes to filing bankruptcy, is profound.

IRAs in Bankruptcy

An IRA or individual retirement account is set up on a tax-deferred basis or to allow for tax-free growth. IRAs typically fall into one of 3 separate categories: Roth, SEP, and Simple. While the rules are different in many states, most Traditional and Roth IRAs have a limit on the amount you can declare exempt. This means that if you have more money in that retirement account than the state or federal limit, the bankruptcy court can take the excess to satisfy your debts and pay back your creditors.

Pension Plans in Bankruptcy

Alternatively, a pension is a retirement account that an employer sets up and maintains for you. When you retire from the company or government entity you can take a onetime lump sum payment or receive monthly annuity payments. As in the case of the woman who was able to exempt her father’s $2 million dollar pension she received when he passed away, exemption on pensions and profit sharing plans is unlimited in most states. This means that 100% of your pension will be protected in a bankruptcy filing

Other Types of Retirement Accounts in Bankruptcy

401(k)s, 403(b)s, Keoghs, and defined-benefit plans are all protected from creditors in a Chapter 7 bankruptcy and won’t affect how much you pay back in a Chapter 13 bankruptcy. There are a few exceptions, but the exemption amounts are unlimited, so you get to keep all this money in a bankruptcy.

Other Special Exemptions and Exclusions

In 2005 Congress made sweeping changes to the bankruptcy code. Many general practice attorneys may not know all the caveats that these changes hold, so if you are considering filing bankruptcy, make sure your retirement account is protected by speaking to a knowledgeable attorney specializing in bankruptcy protection.