Can I Lose My Retirement in a Bankruptcy?

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Congress exempts most retirement accounts from bankruptcy. However, each state and bankruptcy code has its own sets of exemptions, and not all retirement money is protected by bankruptcy status. Learn more about how bankruptcy impacts retirement savings and assets.

Bankruptcy and Retirement Income

Here's how federal bankruptcy law impacts common types of retirement income. States also have their own bankruptcy laws, and in some states, you can choose whether to use federal or state exemptions. In other states, you must use the state exemptions.

States generally follow federal bankruptcy laws regarding retirement income, but it's best to consult a local bankruptcy attorney to discuss specifics.

Social Security

Social Security payments are safe in a bankruptcy case—at least until they’re deposited into your bank account. In some states, cash in bank accounts is not exempt from bankruptcy proceedings. To ensure your Social Security benefits are protected, keep them in a separate account. If you include them in the same account as other income, it becomes difficult for your bankruptcy trustee to know what's Social Security and what's not.

Pensions

Private company pensions are protected if they qualify under the Employment Retirement Income Security Act of 1974 (ERISA). To qualify, these plans must meet certain requirements contained in ERISA and the Internal Revenue Code. While pensions from governments, churches, non-profit organizations, certain partnerships, and tax-exempt organizations are not ERISA qualified, they may still be exempt if they meet other Internal Revenue Code requirements.

401(k) Accounts 

These investment accounts are also exempt from bankruptcy proceedings.

Traditional IRAs and Roth IRAs

Currently, you can protect a total of $1,362,800 in traditional or Roth IRAs. This IRA exemption maximum can be increased every three years and the next expected increase is in 2022.

Annuities

Tax-deferred retirement annuities are exempt. Other annuities are not. For example, an annuity set up to pay lottery winnings will not be exempt.

Will a Reverse Mortgage Help?

Reverse mortgages are designed to let you access your home's equity without leaving your home. Your home equity is the difference between the value of your home and the balance of your mortgage. If your home is worth $150,000 and you owe $100,000 on your mortgage, you have $50,000 in equity.

In exchange for either monthly payments, lump-sum payments, or lines of credit, you agree to relinquish your house to the lender once you pass away or permanently move. This provides an income stream and allows you to continue living in your home during your retirement.

Consult your state and federal exemption guidelines to determine if the equity in your home is protected. Some states allow you to protect 100% of the equity, but most states limit the amount.

Second and vacation homes don't have the same protections in bankruptcy that primary residences do.

Protecting Your Home Equity

Your home equity is one of your most important retirement assets, so it's essential to consider how to protect it if you're filing for bankruptcy.

Suppose you have $50,000 in credit card debt. If you file a bankruptcy case, the court will typically want you to turn over enough property to pay that debt. Even though you owe $50,000, you may not have to pay that entire amount.

Before you pay the debt, your creditor must file a claim, which must follow certain requirements, or the trustee appointed by the court to administer your case can object to the claim and possibly have it thrown out.

Some creditors won't bother to file a claim. And any claim that isn’t filed or allowed by the court will be discharged. There’s a chance you'll pay less than $50,000 on the credit card debt.  

In some cases, you'll have to give up your house, which the trustee would then sell to pay off the debt, the trustee's commission, and all the allowed claims. The court will then refund you anything left over.

Instead of selling your home, you could offer to substitute other nonexempt properties or cash to preserve your house and most of your equity.

Avoid Using Retirement Accounts to Pay Debts

Some individuals consider using their 401(k)s and IRAs to pay off bankruptcy-related debt. This isn't a good idea, though, because it uses protected money to pay debts that could be eliminated by filing a bankruptcy case. Withdrawing funds from your 401(k) or your IRA before age 59 1/2 also triggers significant tax consequences.  

Before taking any action, consult a knowledgeable consumer bankruptcy attorney. It often takes careful planning and timing to satisfy a bankruptcy court's many complex requirements.

Article Sources

  1. Legal Information Institute. "11 U.S. Code § 522. Exemptions." Accessed Oct. 5, 2020.

  2. Legal Information Institute. "11 U.S. Code § 541. Property of the Estate." Accessed Oct. 5, 2020.

  3. NCLC Digital Library. "Increase of Federal Bankruptcy Exemptions, Other Dollar Amounts: April 1, 2019." Accessed Oct. 5, 2020.