One of the best bankruptcy exemptions offered to those filing bankruptcy is the retirement account exemption. As long as your 401K or IRA is ERISA (Employee Retirement Income Security Act of 1974) qualified, then your 401k or IRA will be protected if you file bankruptcy. Amazingly, there are not a lot of limitations to this rule. This is a wonderful law as it is very common for a person’s biggest asset to be their retirement account. Some of the qualified ERISA retirement accounts include 401(k)s, 402(b)s, IRAs (Roth, SEP, and SIMPLE), Keoghs, profit-sharing plans, money purchase plans, and defined-benefit plans. It is important to note that most employer-sponsored retirements plans are ERISA safe in bankruptcy.
Many who file bankruptcy may have also taken out a 401k loan in an effort to avoid having to file bankruptcy. It is important to understand how your 401k loan will be treated in your bankruptcy. First of all, a 401k loan is not considered a regular debt and will not be treated as any other creditor. In other words, a 401k is not dischargeable through bankruptcy and you will still have to repay it after your bankruptcy is completed. Additionally, in a Chapter 7 in which assets are available to be liquidated, your 401k loan would not receive any portion of the liquidated funds as a normal creditor would. In a Chapter 13, your 401k loan would not be part of your chapter 13 plan. However, you most likely will be allowed to still make payments towards the loan through automatic deductions on your paystubs.
Can you take out a 401(k) loan before filing bankruptcy?
Yes. You can take out a 401(k) loan before filing bankruptcy. However, there are several considerations you should first think about because you will be stuck repaying that loan after bankruptcy. You do not want to use a 401k loan to pay off any debts unless it is going to completely solve your debt issues. This is because, again, you will still have to repay the 401k loan after bankruptcy. Also, as long as the funds remain in your 401k, they will be protected. As soon as the funds are released from your 401k, they lose that protection. Finally, funds received from a 401k loan can be treated as income on your MEANS test. This could cause you to no longer qualify for a Chapter 7 because your income is too high.
Can you take out a 401k loan during or after bankruptcy?
Yes. But it is still never advised. If you are in a Chapter 13, you will have to get the court’s approval first.
Paying off your 401k loan before filing bankruptcy.
Since a 401k loan is not treated as a normal debt in bankruptcy, if you payoff the loan before filing bankruptcy, your Trustee could potentially undue the transfer and redistribute the funds used to payoff your 401k loan to your other creditors. But, this is very jurisdiction dependent. In some jurisdictions, there is rarely any objection over the repayment of a 401k loan.
Regardless of whether you have a 401k loan, it is always important to talk about your 401k and how it will be affected by bankruptcy with an experienced bankruptcy attorney. Please call the Law Office of David M. Goldman, PLLC today.