Your Retirement Plan in Bankruptcy

People in financial distress often see their retirement accounts as a ready pool of cash that they believe will save them from having to file Chapter 7 or Chapter 13 bankruptcy to get a handle on their debts.

But their attempt to "do the right thing" by using their retirement funds to pay down unsecured debts will likely end up costing them more than if they file bankruptcy. They often don't realize that withdrawing money from retirement funds can carry a hefty tax penalty if they're under retirement age and fail to pay back the money they borrowed.

Potential bankruptcy filers often don't understand that most of their debts, particularly unsecured debts like medical bills and credit card balances, will be eliminated (discharged) in a bankruptcy. The money in their retirement funds is actually protected (exempted) from the reach of creditors. Therefore, bankruptcy protection will allow them to get rid of the debt (and the debt collectors) but preserve an important asset.

Protecting ERISA-Qualified Retirement Funds and IRA Balances During Bankruptcy

In most cases, when you file for Chapter 7 or Chapter 13 bankruptcy, you get to keep your pension and retirement plan funds. But a few limitations exist. When considering bankruptcy, it's important to learn the essential rules governing your retirement plan, including when you can keep or "exempt" your retirement account balance and how to avoid losing retirement funds.

You Can Keep (Exempt) Most Retirement Accounts

You don't lose everything you own when filing bankruptcy. You can use bankruptcy exemptions to protect property you need to work and live, such as some equity in a home, a modest car, and household belongings.

Fortunately, virtually all ERISA-qualified retirement accounts and pension plan funds are excluded from bankruptcy. But the protection is limited. ERISA-qualified retirement accounts and pension plan funds are protected from creditors as long as the funds remain in the actual account. Funds are treated differently after being withdrawn, and you stand a greater chance of losing them. You'd need to protect the funds with a cash or wildcard exemption.

Some states also have exemptions protecting retirement accounts. Learn more about your state's exemptions and keeping property in Chapter 13 bankruptcy.

Fully Protected Retirement Accounts

With a few exceptions, bankruptcy exemption amounts for retirement accounts are unlimited, so the entire amount of the retirement account is protected. Plans subject to this exemption include ERISA-qualified pension plans, such as:

• 401(k)s
• 403(b)s
• IRAs (Roth, SEP, and SIMPLE, but see limitations discussed below)
• Keoghs
• profit-sharing plans
• money purchase plans, and
• defined-benefit plans.

Keep in mind that a general savings account, investment account, or stock option plan won't be protected if it isn't an ERISA-qualified plan—and many are not.

Also, few states have exemptions that protect bank and investment account funds. Even when they do, the coverage is minimal. For instance, $300 isn't uncommon. You'll lose unprotected funds in both Chapter 7 and Chapter 13 bankruptcy (the money will be used to pay creditors).

Traditional and Roth IRA Limitations

For IRAs and Roth IRAs, the exemption from creditors (the amount the bankruptcy court cannot touch) is limited to $1,512,350 per person. If you have more than this in your retirement accounts, the bankruptcy court can take the excess to pay back your creditors. The exemption applies to the combination of all of your retirement plans; you can't exempt $1,512,350 for each plan.

This amount adjusts every three years to account for the cost-of-living increases. The most recent adjustment occurred on April 1, 2022. The limit will adjust again in 2025. (11 U.S.C. § 522(n) (2023).)

Withdrawn Retirement Benefits Aren't Exempt

Although the funds in your retirement accounts are exempt from creditors (subject to the limitations discussed above), retirement benefits paid to you as income aren't exempt. Here's how retirement income factors in:

• Chapter 7 bankruptcy. If you receive a monthly payment from a pension or retirement account, the court will consider it income that gets figured into your Chapter 7 means test qualification. In a Chapter 7 bankruptcy, the bankruptcy court cannot take any retirement benefits that are necessary for your support, but it could take amounts over and above what you need for your support and use it to repay your creditors.
• Chapter 13 bankruptcy. In this chapter, retirement income will help determine what portion of your unsecured debts you must repay in your Chapter 13 repayment plan.

Finding out what will happen to your retirement funds in bankruptcy is important. Many people at the "withdrawing retirement funds" stage of life are often judgment proof and don't need to file for bankruptcy. It's prudent to protect your interests by meeting with a qualified bankruptcy lawyer.

Need More Bankruptcy Help?

Did you know Nolo has been making the law easy for over 50 years? It's true—and we want to make sure you find what you need. Below you'll find more articles explaining how bankruptcy works. And don't forget that our bankruptcy homepage is the best place to start if you have other questions.

We wholeheartedly encourage research and learning, but online articles can't address all bankruptcy issues or the facts of your case. The best way to protect your assets in bankruptcy is by hiring a local bankruptcy lawyer.

Updated March 2023