If you’ve found yourself in a precarious financial situation and overwhelmed with debt you can’t repay, bankruptcy may be your best option. You may be reluctant to declare bankruptcy because you fear it will wipe out your hard-earned retirement savings. However, in most situations, this is not the case.
Defining the Most Common Types of Bankruptcy
Before diving into bankruptcy’s implications for your nest egg, here is an explanation of the two most common types of bankruptcy.
Chapter 7 bankruptcy or liquidation bankruptcy, allows you to discharge all or most of your debt. A court-appointed trustee will sell all or a portion of your nonexempt property. You can keep your home and car and will receive automatic court protection from creditors. Chapter 7 bankruptcy also stops lawsuits and garnishments.
Chapter 13 bankruptcy, or reorganization bankruptcy, stops repossessions and foreclosures to save your home or investment. It also stops lawsuits and garnishments. In Chapter 13, you pay off your debt over three to five years according to a court-mandated plan.
Should Retirement Funds Be Used to Pay Off Debt?
If you’re considering tapping into your retirement accounts instead of declaring bankruptcy, you may want to reconsider. Here’s why:
- If you withdraw funds from your 401(k) or an IRA before the age of 59.5, the IRS will impose a 10% tax penalty.
- These penalties may ultimately cause you to incur more debt.
Here are two other good reasons to hold onto those retirement savings and file for bankruptcy instead:
- If you’ve been contributing to a qualified retirement plan before filing for Chapter 13 bankruptcy, you can continue to do so without including it as disposable income for debt repayment purposes.
- Because Chapter 7 is a one-time disposal of non-exempt assets, you can contribute to your retirement accounts under that scenario as well.
What To Know About Bankruptcy and Retirement Savings
Here’s the good news; with bankruptcy and retirement accounts, you are almost always protected when you file for bankruptcy.
All of the “defined contribution plans” are safe from creditors under the Employee Retirement Income Security Act (ERISA). Defined contribution plans include:
- Traditional 401(k)s
- Safe harbor 401(k)s
- SIMPLE 401(k)s
- Automatic enrollment 401(k)s
- Simplified employee pension plans (SEP)
- SIMPLE IRA plans
- Employee Stock Ownership Plans (ESOP)
- Profit-sharing plans
Although not protected under ERISA, traditional IRAs and Roth IRAs have been substantially protected from creditors in the event of bankruptcy since President George W. Bush signed the Bankruptcy Abuse Protection and Consumer Protection Act of 2005. Currently, both traditional and Roth IRAs are protected to a total dollar value of $1,512,350. This amount changes every three years, so ask your lawyer for bankruptcy about the current limit.
There are a few exceptions.
The bankruptcy court can take any amount over $1,512,350 in a traditional or Roth IRA to pay your debts. If you receive monthly retirement benefits, this overage will be considered part of your monthly income and used to repay your creditors.
Sawin & Shea, LLC: Helping Resolve Debt and Preserve Your Retirement Savings
If you’re struggling to pay off debt for any reason, the attorneys at Sawin & Shea, LLC can help determine if bankruptcy is a good option for you and then walk you through the entire process. We will also help you preserve your retirement savings so you get a fresh start while ensuring your future is secure. We understand that filing for bankruptcy can be a distressing proposition. That is why we are committed to providing compassionate, nonjudgmental assistance. Give us a call or schedule a free consultation – 317-759-1483.