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What Happens to a Retirement Plan Account in Bankruptcy?



Understandably, bankruptcy debtors often worry about what will happen to their retirement plans when they file for bankruptcy protection. Consumer bankruptcy attorneys frequently encounter prospective debtor candidates with $25,000 in IRA (individual retirement account) or 401(k) retirement plan accounts, even when they may have no equity in their homes and no cash in their savings or checking accounts at the local bank. As a result, these clients are very interested in preserving that precious asset or nest egg and safeguarding it from the grasp of creditors within the protective arms of the bankruptcy statutes, if at all possible.

How Is a Retirement Plan Treated in Bankruptcy?

As a general proposition, monies saved and amassed in an ERISA (Employee Retirement Income Security Act)-qualified retirement plan are deemed exempt assets within the bankruptcy context. This means that a debtor is able to file for bankruptcy protection and safeguard such funds from the grasps of creditors, the trustee, and any loss or forfeiture within the bankruptcy proceeding. This protection applies in filing Chapter 7 and filing Chapter 13 bankruptcy cases. Most prospective debtors are quite relieved to learn that their retirement plans, if they qualify under the various bankruptcy statutory provisions, are protected from creditors' and the standing bankruptcy trustees' reaches.

Typical Hypothetical Bankruptcy Scenarios

The practical impacts of this protection are huge. For example, a typical Chapter 7 liquidation bankruptcy case can discharge (or, in other words, permanently excuse by operation of bankruptcy law) six figures in unsecured credit card debts. At the same time, that identical Chapter 7 debtor is able to preserve an IRA account with a $30,000 balance. So, the debt burden is removed, and the savings in the retirement account are preserved intact.

"Where Is the Fairness?" Creditors Complain

To some creditors, the dichotomy may seem unfair that a debtor can remove the irresponsible overspending frequently associated with credit card debt, while at the same time, emerging from a bankruptcy case with a retirement nest egg intact. It is important to remember, however, that the statutory intent behind bankruptcy relief is the opportunity for a debtor to have a financial fresh start to rebuild credit and finances without the pressures and stressors of creditors, payments, and mounting interest and late fees. Besides, bankruptcy is a creature of Congressional design, and any idiosyncrasies within the statutory scheme are the fault or responsibility of legislators and not the individual debtors who seek to take advantage of its relief and protections. If you have questions about consumer bankruptcy and its treatment of any assets, including retirement plans or accounts, it is prudent to consult with bankruptcy counsel. Such an attorney can further discuss your available options and remedies within the bankruptcy context.