What Happens to My 401(k) If I Go Bankrupt?
Your 401k plan provides for certain protections if you go bankrupt. Because 401k plans are retirement accounts, they are governed by ERISA rules. ERISA is the Employee Retirement Income Security Act. While 401k plans do provide significant protections, they do not provide total protection from bankruptcy. Make sure you understand how your 401k plan is protected and under which circumstances it is not protected.
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Types
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There are two types of 401k plan protected during a bankruptcy. The traditional 401k plan is a plan that allows pretax contributions. Withdrawals are taxed at ordinary income tax rates. Roth 401k plans only allow after-tax contributions. Withdrawals are not taxed during retirement.
Significance
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The significance of 401k protections against bankruptcy mean that your 401k account is not part of your bankruptcy. This money is generally excluded under most circumstances. You may continue to contribute to your 401k plan and invest in it as you normally would.
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Benefit
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The benefit of creditor protection inside of a 401k plan is that you do not need to worry about whether you can rebuild your retirement savings prior to retirement. Since your retirement is not touched by creditors, you have the peace of mind of knowing that your retirement plans won't be disrupted by a financial mistake during your lifetime. You may also transfer your 401k plan to another 401k plan or Individual Retirement Account (IRA) without losing your retirement savings.
Disadvantage
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The disadvantage to a 401k plan is that the protections do not apply to tax debts. The Internal Revenue Service may seize your 401k to satisfy a tax debt. If this happens, then you will have to rebuild your retirement savings over time. This could cause you to retire later than you originally wanted to.
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