Retirement accounts are important tools for retirement planning. One of the biggest myths about bankruptcy is that you will lose everything, including your retirement accounts. However, nothing could be further from the truth. While bankruptcy cannot magically wipe away all the debt you’ve incurred, it does help you keep your retirement account intact.
The protection actually comes from two different legal sources, depending on the account type:
- Employer-sponsored plans — 401(k)s, 403(b)s, and traditional pensions are protected under federal ERISA law. These funds generally aren’t even considered part of your bankruptcy estate in the first place, meaning they’re not something a trustee can reach regardless of the amount.
- IRAs (traditional and Roth) are protected under a specific federal bankruptcy exemption (11 U.S.C. § 522(n)), which is available to filers in every state including California, regardless of which state exemption system you use. This exemption is capped: as of the most recent adjustment, it protects up to roughly $1.7 million in IRA funds per person, an amount that adjusts for inflation every three years. For the vast majority of filers, this cap is far higher than what’s actually in their IRA, so in practice it covers the full account.
One notable exception: inherited IRAs are not protected by this exemption. The U.S. Supreme Court ruled in Clark v. Rameker (2014) that funds inherited in an IRA don’t count as the debtor’s own “retirement funds” for exemption purposes, since the money wasn’t set aside by the filer for their own retirement. If you’ve inherited an IRA, it’s worth discussing separately with an attorney — the usual “your retirement account is safe” answer doesn’t automatically apply.
Allowing you to retain your retirement account is one of the most important benefits of adequately filing bankruptcy with help from an experienced bankruptcy lawyer in San Diego. However, you should still learn more about what you need to do to keep your retirement funds and what you should avoid doing to not jeopardize them.
How can I keep my retirement accounts in bankruptcy?
You can keep almost all retirement accounts including your 401k, 403b, pension plans and IRAs when filing either Chapter 7 or Chapter 13 bankruptcy. This is a big relief for bankruptcy filers because they get to hang on to their retirement accounts and at the same time get a fresh start and wipe out their debt.
However, while this is undoubtedly true, it’s important to also know what you have to avoid before filing bankruptcy. Avoid doing any of the two following actions:
Don’t make early withdrawals
Many times individuals make the mistake of taking an early withdrawal from their retirement account and then use it to pay debt that would have been discharged in a bankruptcy. This includes loans and cashing out part of a retirement account. Not only is this one of the most common, but also one of the biggest mistakes you can make prior to successfully filing bankruptcy.
The entire reason behind filing for bankruptcy is to receive relief for some of the debt you have accumulated. Withdrawing from your retirement account early will leave you with less financial security in times when you need it most. Indeed, draining your retirement account is a big mistake especially because you can preserve those funds when filing bankruptcy.
Additionally, early withdrawal of retirement funds creates a big IRS penalty and tax liability. This is something you definitely want and have to avoid in order to maximize your chances of a successful bankruptcy.
Don’t use your retirement account to pay off debt
We keep seeing people who have depleted their retirement accounts trying to pay off debt that would have been wiped out in a bankruptcy. But, we have to advise that this is the last thing you should consider doing, as bankruptcy is a process that will help eliminate some of your debt.
That is why even thinking about using retirement funds to repay debt is a sure sign of financial trouble that indicates that you should immediately contact an experienced bankruptcy attorney. They will be able to review your retirement accounts to make sure they are protected in bankruptcy.
If you have a loan against your 401(k)
A loan you’ve taken against your own 401(k) works differently from other debt in bankruptcy. Since you’re technically borrowing from yourself, this isn’t debt that gets discharged the way credit card balances are. If you stop repaying it, most plans will treat the outstanding balance as a distribution — which can trigger income tax and, if you’re under 59½, an early withdrawal penalty. If you have an active 401(k) loan and are considering bankruptcy, it’s worth flagging to your attorney early, since the timing can matter.
Contact an experienced bankruptcy lawyer in San Diego
Now that you know almost all retirement accounts are protected, don’t jeopardize your golden years. Instead, find dependable legal professionals who will help you learn the details of different types of bankruptcy and help you choose the most suitable option for your particular situations. This is the best way for preserving your retirement account and ensuring a successful bankruptcy claim.
Take the first step and contact the Law Offices of Mark L. Miller at (619) 574-0551 for a free consultation to discuss planning for your financial future. We are the leading bankruptcy lawyers in San Diego, and we have the knowledge and the qualifications necessary to help you. You can easily locate our offices in the vicinity of Old Town San Diego State Historic Park. We’re here to help you any way we can.
FAQs
Are 401(k)s completely safe in bankruptcy, no matter the balance?
In almost all cases, yes, employer-sponsored plans like 401(k)s and pensions are protected under federal ERISA law and generally aren’t part of the bankruptcy estate at all, regardless of the account balance.
Is there a limit on how much of my IRA is protected?
Yes. Federal law caps the bankruptcy exemption for IRAs at roughly $1.7 million per person (a figure that adjusts periodically for inflation). Most filers’ IRA balances fall well under this cap.
What if I inherited an IRA from a parent or relative?
Inherited IRAs are treated differently and are generally not protected by the retirement account exemption, based on a 2014 Supreme Court ruling. If this applies to you, talk to an attorney before assuming the account is safe.
Can creditors touch my retirement account before I file bankruptcy?
Retirement accounts covered by ERISA generally have strong protection from creditors even outside bankruptcy. IRAs have some protection under California and federal law outside of bankruptcy too, though the details differ from the bankruptcy-specific exemption described above.
