Retirement Accounts in Bankruptcy
ARE MY RETIREMENT ACCOUNTS PROTECTED IN BANKRUPTCY?
This is one of the most common questions we get, and the answer is nearly always a resounding YES!!! Federal and state laws strongly protect retirement accounts in and out of bankruptcy. If you are filing bankruptcy, the following retirement accounts are protected:
- IRAs (Traditional and Roth up to $1,245,475)
- 401(k)s and 403(b)s
- Keogh plans
- Most other defined benefit plans
- Social Security
- Railroad Retirement Board Benefits
- VA Disability and Retirement benefits
The one glaring exception to this arises out of a recent US Supreme Court decision which held that an inherited IRA is not protected in bankruptcy as a retirement account (though there may be other ways that an inherited IRA could be protected in bankruptcy).
What this means is that neither the bankruptcy court nor your creditors can force you to use any of your retirement accounts to pay your debts (though the IRS in extreme cases can). Your retirement accounts will be protected before, during, and after bankruptcy so that you can have a secure retirement.
Many of our clients have made the mistake of cashing out their retirement accounts to pay their creditors. This is a mistake for a couple of reasons:
- They didn’t have to cash out their retirement accounts to pay their creditors! Federal and state laws protect retirement accounts in AND out of bankruptcy. This means that no matter how aggressively your creditors may be hounding you, or even suing you or garnishing your wages, they can’t touch your retirement accounts. Nor can the bankruptcy court.
- People often underestimate the cost of cashing out their retirement accounts. The IRS charges a 10 percent tax penalty for withdrawing your 401k, 403b, IRA, Roth IRA or pension before the age of 59 ½. In addition to the 10% penalty, you must pay ordinary income taxes at both the federal and state levels on any taxable gains in the year that the money is taken out. And don’t forget, your retirement money you take out will likely push you into a higher tax bracket.
- People never get their retirement funds back. By cashing out retirement funds, this money is effectively lost AND the future gains that this money would have earned is also lost. Money earning 7% average annual returns will double every 10 years, meaning that $1,000.00 will grow to $4,000.00 in 20 years. If the $1,000.00 is taken out at the beginning, you are not just losing the $1,000.00, but also the $3,000.00 that would have been gained on that money.
- It usually doesn’t avoid bankruptcy, but just prolongs the debt. Often people who attempt to avoid bankruptcy by cashing out their retirement end up filing for bankruptcy anyway.
- Bankruptcy is not as bad as people think. Before cashing out your retirement account, sit down with us to learn about your options. Bankruptcy may very well be your best choice. And learning about bankruptcy will most likely remove your desire to cash out your retirement accounts.
PLANNING FOR RETIREMENT
U.S. News reports that the rate of bankruptcy filings among the elderly has been growing rapidly in recent years. The rate of bankruptcy filings among the elderly increased threefold in the 25 years between 1991 and 2016, according to a report by the Consumer Bankruptcy Project. Whether it is because of a forced early retirement, injury or illness, or insufficient retirement savings, many people approaching or in retirement are confronting debt that is not manageable.
Approaching retirement with unmanageable levels of debt is unpleasant and unsettling. It can cast a dark cloud over what should be your golden years. But it doesn’t need to be that way. Federal and state laws strongly protect retirement accounts and income with the intention that people who are of retirement age have put in many long years of work and should be able to retire without worrying that their income could be taken away by creditors. When you are living on a fixed income, bankruptcy and a fresh financial start are even more important to help you live out your retirement years with peace of mind and financial stability. Do not avoid the prospect of a bankruptcy filing because of concerns or stories that people have shared with you. Get the facts so you can take the action that is most appropriate for your situation. At Prescott Pearson & Tande, PA, we have extensive experience helping people nearing and in retirement resolve their debts and get a fresh start.