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Does filing for bankruptcy mean forfeiting your retirement funds? For most people, it doesn't. Most retirement accounts are protected in bankruptcy, which means they are not used to repay your debts. However, there are exemption limits on some types of accounts and there may be consequences for withdrawing your retirement money prior to bankruptcy. Before you file, it's important to know the details.
Are Retirement Accounts Protected in Bankruptcy?
Most retirement accounts are protected by federal bankruptcy rules, though some limitations apply. Additionally, state rules may determine what you're allowed to keep, so it's a good idea to work with a bankruptcy attorney in your area who is familiar with all applicable laws: federal, state and local. Examples of retirement accounts that are protected in bankruptcy include:
- Employee Retirement Income Security Act (ERISA)-qualified retirement accounts: Most 401(k), 403(b), profit-sharing and employer-sponsored deferred compensation plans are fully protected in bankruptcy without limitation. To find out whether your employer-sponsored retirement account is ERISA-qualified, contact your plan administrator.
- SEP-IRA, SIMPLE IRA and most rollover IRAs: These accounts are fully protected under the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA).
What Are Exemption Limits for IRAs?
Traditional and Roth IRAs are also protected under BAPCPA, up to a limit of $1,512,350 per person. This limitation applies to the combined holdings in all IRAs and not to each individual IRA account. If you have more than the allowed amount in your combined IRA accounts, the surplus may be used to repay your creditors. The exemption limit is adjusted every three years according to the cost of living, with the next adjustment scheduled to happen in 2025.
Which Accounts Aren't Protected?
Without a separate cash exemption, money saved in regular savings accounts, investment accounts, stock option plans or other non-retirement bank or brokerage accounts is generally not protected and may be used to pay your creditors—even if you think of the money as your retirement savings.
How Is Retirement Income Treated in Bankruptcy?
If you're already retired and collecting retirement benefits, the income you receive from your retirement accounts may affect your bankruptcy. Here's how:
To file for Chapter 7, or liquidation, bankruptcy, you must have below-median level income for your state or pass a means test to demonstrate that you're unable to repay your debts. The test takes into account income, assets, unsecured debt and expenses. Monthly retirement benefits from a pension or retirement account may be used to determine income as part of a Chapter 7 means test. Retirement benefits that are considered to be above and beyond what's needed for your support may be used to repay your creditors.
In a Chapter 13 bankruptcy, your income helps to determine how your debts will be repaid. The goal in Chapter 13 is to reorganize your debt, preserve many of your major assets and repay at least some of what you owe over the course of three to five years. Retirement benefits may factor into your income calculation, possibly increasing the amount of debt you'll be expected to pay back.
Social Security benefits are considered exempt, as long as you keep Social Security payments separate from the rest of your money. Don't deposit your Social Security checks or payments into a checking account that you also fund with other income. Use a separate bank account for Social Security benefits.
Protect Your Retirement Funds in Bankruptcy
Before you file for bankruptcy, consider meeting with a bankruptcy attorney in your area. They can help you navigate federal, state and local bankruptcy rules to best protect your retirement assets and make sure your retirement income, including Social Security, is reported properly. They can also help you think through alternatives to bankruptcy if they might be appropriate for you.
An additional note: Taking money out of a retirement account to pay down debt may seem like a good way to postpone or reduce the impact of a bankruptcy. But explore your options with an attorney first.
Withdrawals from tax-deferred retirement accounts are taxable as regular income. If you're younger than 59½, you may also pay a 10% early withdrawal penalty. Moreover, once withdrawn, your retirement funds are no longer protected in a bankruptcy and may prevent you from passing a Chapter 7 means test or inflate your income in Chapter 13. Before taking this step, find out whether filing bankruptcy is a better next step for you.
The Bottom Line
It's important to consider how bankruptcy might affect your retirement savings and income. While there are protections in both Chapter 7 and Chapter 13 bankruptcies to help you keep your retirement accounts from being seized to repay creditors, income from retirement benefits may be used to help determine your ability to repay debts. Nonqualified accounts may not be protected in a bankruptcy, and rules may differ depending on your state. Consulting with an attorney may help you keep your assets while navigating all applicable rules.