When you file a Chapter 7 bankruptcy petition, all of your possessions, including investments, are considered to be part of your bankruptcy estate. Unless you are able to apply an exemption to the property, thereby excluding it from your bankruptcy estate, the funds in a mutual fund are subject to forfeiture to your creditors.
Chapter 7 Bankruptcy
In a Chapter 7 bankruptcy, any non-exempt assets you have are seized by a court-appointed trustee and sold to pay your creditors. This means that any eligible property is sold at auction and any investments that are not protected by an exemption are liquidated. The funds are used to compensate your creditors and any eligible unpaid debts at the end of the case are wiped clean in your bankruptcy discharge.
Bankruptcy law allows you to claim certain property as exempt from your bankruptcy estate, thereby preventing your creditors from taking it. These exemptions typically cover a certain amount of equity you have in your home and car, furniture, clothes and various other items. As exemptions are set by both federal and state law, the specific type and value of property you can exclude varies depending on where you live. However, many states include a "wildcard" exemption that you can apply to any property, including a mutual fund or other investment, up to the exemption's dollar limit.
Community Property States
The marriage laws of some states treat the property and debts acquired by either spouse during the marriage as jointly held by both spouses. If you live in one of these community property states, your filing of a bankruptcy petition will automatically put your spouse's ownership interest in the mutual fund at risk for liquidation by the trustee, unless it is subject to an exemption. In all other states, which follow an equitable distribution scheme, if the trustee takes a joint mutual fund, he must prove to the court that there are sufficient funds in the account to pay the spouse her half of the balance, after any taxes and fees are paid.
Chapter 13 Cases
If you file a Chapter 13 bankruptcy, the trustee does not seize your assets. Rather, you are placed on a three- to five-year repayment plan. Although your jointly held mutual fund is not liquidated, as it could be in a Chapter 7 case, you will be required to pay your creditors an amount equal to your investment over the life of your repayment plan on top of what you would otherwise owe based on your monthly disposable income. Therefore, the balance of your mutual fund is likely to make your Chapter 13 repayment plan more expensive.