Bankruptcy Laws & IRAs in California
While bankruptcy laws in general can be confusing, California adds an extra layer of complexity by providing two systems of bankruptcy exemptions from which you must choose. Bankruptcy exemptions allow you to keep a certain amount of property in bankruptcy, so they are particularly relevant if you are trying to keep assets such as an IRA. Whether you can keep your IRA in a California bankruptcy can also be affected by the type of bankruptcy you select.
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Reorganization Bankruptcy
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Under a reorganization bankruptcy, you still must pay back a certain amount of your debt. This form of bankruptcy, also known as Chapter 13 bankruptcy, protects assets such as your IRA from liquidation. If you file Chapter 13 in a California court, you do not have to worry about losing your IRA, no matter how much money is in it.
Liquidation Bankruptcy
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If you file a liquidation bankruptcy, you may lose at least part of your IRA. Liquidation bankruptcies, also known as "straight" bankruptcies, are filed under Chapter 7 of the bankruptcy code and require debtors to sacrifice assets to help pay creditors. Each state, including California, has the right to create its own bankruptcy exemptions. Residents of California are entitled to use the full value of these exemptions to protect or "exempt" your assets from liquidation. Assets that you cannot protect using California exemptions become property of the trustee, for distribution to your creditors.
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California Exemption System 1
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In California, you must choose which of the state's two exemption systems you will use at the time you file your bankruptcy petition. Once you have made your selection, you cannot change it. If you are married, you might prefer California exemption System 1, particularly if you own a home. Under System 1, there is a homestead exemption of $50,000, which rises to $75,000 if you are married. System 1 also protects both traditional and Roth IRA accounts up to a maximum value of $1,095,000 per person.
California Exemption System 2
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Exemption System 2 in California limits the homestead exemption to just $20,725, even for a married couple. However, if you do not own a home, System 2 allows you to transfer that amount to the "miscellaneous" exemption, also known as the "wild card" exemption. You can combine the $1,100 miscellaneous exemption with the unused balance of your homestead exemption to protect up to $21,825 in any type of property if you do not own a home. As with System 1, System 2 protects up to $1,095,000 in a traditional or Roth IRA, again per person. If you were to apply the "wild card" exemption to your IRA, you could protect up to $1,116,825 in a single IRA.
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