What happens to your 401k or IRA in bankruptcy can be an area full of anxiety for someone in financial trouble. After all, many people have a lot of money in these retirement accounts. Good for them, they have diligently saved for the day when they cannot, or do not, want to work anymore. Well Congress thought that saving in your 401k or IRA was a good thing as well, and has put protections in the bankruptcy code to help make sure that even if you file bankruptcy you will not lose your retirement savings.
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To really understand how this works though, a little background is required. First we need to understand what happens to all of your property when you file bankruptcy. Basically everything you own gets put into the bankruptcy estate. Think of the estate as another entity or a company even. This new entity is controlled by the bankruptcy trustee. The trustee takes all of the property in the estate, which we now know is everything you used to own, and sells it to make money and pay off creditors. That sounds terrible I know. The good news is that not really everything you own becomes property of the bankruptcy estate. There are some types of property excluded from the bankruptcy estate, for example wages you earn after the bankruptcy petition is filed are not property of the estate. You get to keep those wages, not the trustee or your creditors. The good news does not end there, because you also get to exempt some property from the bankruptcy estate as well. Exemptions are different than having something excluded from the estate, they are more like a take back. The exempted property actually becomes part of the bankruptcy estate but is exempt from being given to creditors. Instead the bankruptcy debtor gets this property back. When it comes to your 401k and your IRA accounts, these are matters of exemption. They become property of the bankruptcy estate, but you can exempt them under either federal or state law, and sometimes both.
So what exemptions apply to a 401k and an IRA? That gets a little complicated. See, depending on the state you live in, you may only be able to use that state's exemption laws. These are called opt out states, and if you live in those states you must use that states exemption laws. For example, Ohio is an opt out state, and in Ohio the exemption statute applicable to an IRA is Ohio Revised Code 2329.66(A)(10)(c). The exemptions will be different in different states, but in Ohio you get to exempt 100% of an IRA.
In some states you will be able to pick which exemptions will apply to your bankruptcy case. You can go with the federal exemptions, or the state exemptions that apply, but not both. So you cannot pick the federal homestead exemption and then try and use your state's IRA account exemption.
Now, in some cases you may need to use both federal and state exemptions. I know that kind of contradicts what I just said in the previous paragraph. The tricky part here is that you can use federal non-bankruptcy exemptions along with your state's bankruptcy exemptions. The federal non-bankruptcy exemptions only apply in very specific circumstances. However for a 401k account, Congress specially exempted them in section 522(b)(3)(C). So even if you are in an opt out state, your 401k is probably protected by federal law.
So now that we have established that your applicable exemptions may protect your retirement account, lets talk about whether your retirement account can be excluded altogether from the bankruptcy estate. Remember at the beginning of this article about property of the bankruptcy estate. Some property is excluded from this estate, and this includes 401k plans that have a non-alienation provision in them preventing creditors of plan participants from garnishing or attaching the plan benefits. This means that if your 401k is ERISA qualified then it is probably excluded from the bankruptcy estate. This is better than an exemption because the account would never become part of the bankruptcy estate and no exemption is needed to keep it.
This is complicated stuff, and this is just a brief overview, so make sure if you are going through a bankruptcy to sit down with qualified counsel who can advise you on your best course of action. Maximizing your exemptions in bankruptcy is very complicated and very important, go find a qualified bankruptcy attorney.
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