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Retirement Plans & Bankruptcy

When you have to file for bankruptcy, you might make payment arrangements with your creditors to pay back at least some of your debts. But you could also lose a substantial amount of your assets and personal savings. With Chapter 7 bankruptcy, you may lose all of your assets, but you will discharge all of your debts. With Chapter 13 bankruptcy, you get to keep all or most of your possessions, but you are required to repay at least some of your debts. Debt payments may be reduced along with the total debt amount. Although your retirement accounts are usually protected, those protections might be limited. You must understand when you are protected and when you are not.

  1. Types

    • Retirement accounts include Individual Retirement Accounts (IRAs), 401(k) plans and annuities. An IRA is a retirement account that may be employer-sponsored, such as a Simplified Employee Pension (SEP) and a Savings Incentive Match Plan for Employees (SIMPLE), or may be an individual plan, such as traditional and Roth IRAs. A 401(k) plan is an employer-sponsored plan. Employer-sponsored IRAs and 401(k)s are only available through your employer. An annuity is considered a non-qualified retirement plan because it fails to meet certain requirements of the IRS and therefore does not receive all the tax benefits that an IRA and 401k receive.

    Benefit

    • The benefit of the bankruptcy protections afforded to retirement accounts means that you won't have to open up a new retirement account and start over with your retirement savings if you file for bankruptcy. A 401(k) plan is protected from nearly all creditor claims. IRAs are protected from creditor claims up to $1 million. Annuities are protected by state laws. Although the protections vary widely, most states offer at least some protection and some provide total exemption against all creditor claims.

    Disadvantage

    • All protections are limited in at least one respect: the IRS can seize any and all retirement funds to satisfy an unpaid tax bill.

      The Bankruptcy Abuse Prevention and Consumer Protection Act protects up to $1 million in IRAs. However, any dollar amount in excess of $1 million may be subject to creditor claims in bankruptcy. If your IRA is larger than $1 million, you could lose a part of your retirement account to your creditors.

      The disadvantage with annuities is the lack of uniformity. For example, some states, like California, protect all the annuity's proceeds, while other states, like Colorado, do not afford any protections for annuities.

    Expert Insight

    • When saving money for your retirement, a 401(k) plan provides the most protection. According to "Wall Street Journal" contributor Kelley Greene, in an article titled, "How to Protect 401(k)s and IRAs From Creditors" (May 9, 2009), a 401(k) plan offers the strongest protection at the federal level as part of Employee Retirement Income Security Act (ERISA). Because of this, you should consider using a 401(k) plan if you are worried about ever having to file for bankruptcy. The portion of your retirement savings that is in a 401(k) plan will be wholly protected.

      You may also consider using insurance contracts. Some states provide exceptional legal protections from creditors on cash value life insurance and annuity policies. These protections may include up to 100 percent of the proceeds of the policy, depending on what state you live in.

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