Can They Touch Your Disability if You Go Bankrupt?

By Tom Streissguth

Medical and other expenses can pile up fast if you're disabled. If you are considering the bankruptcy option, there may be consequences regarding your disability benefits. The law generally holds that disability benefits are exempt from seizure by a bankruptcy trustee. However, there are exceptions to this general rule.

Medical and other expenses can pile up fast if you're disabled. If you are considering the bankruptcy option, there may be consequences regarding your disability benefits. The law generally holds that disability benefits are exempt from seizure by a bankruptcy trustee. However, there are exceptions to this general rule.

What is Bankruptcy?

In a Chapter 7 bankruptcy case, you petition a federal court for protection from your creditors. A court-appointed trustee seizes all of your assets that are not legally exempt to apply toward repayment of the creditors. The law protects "exempt" assets from seizure. In a Chapter 13 bankruptcy, you set up a schedule to repay a percentage of your debts. In drawing up the plan, the trustee may consider any income you are earning, unless it is exempt. When you have completed the requirements for a bankruptcy case, the law allows discharge (cancellation) of all debts that can be legally discharged.

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Exemptions

Property you own that can be seized by the trustee is part of your bankruptcy estate. Income or assets that are exempt are held out of the estate. You are allowed to keep exempt assets, and in a Chapter 13 bankruptcy the trustee does not consider those assets in drawing up a repayment plan. Exemptions include a portion of your equity in your principal residence, as well as a car, books, a limited amount of jewelry, business tools that you need to earn a living, as well as Social Security disability benefits.

Disability Benefits

Bankruptcy law exempts various kinds of disability benefits. These include monthly benefits you may be receiving from the Social Security Administration, no matter what the amount. The trustee may not seize these assets to repay creditors, nor may the court consider Social Security disability benefits as income in the "means test" calculation that determines if you are eligible for bankruptcy protection. State and private disability payments are included in the means test, since the bankruptcy law does not specifically exclude them.

Effect

In effect, all types of Social Security disability benefits are exempt in bankruptcy. This includes lump-sum back benefit payments paid when Social Security approves a disability claim. The law is not as clear on private disability benefits, for example those received through an employer-sponsored disability plan. Several court decisions have found that these benefits are partially exempt, meaning you can only protect that portion of the benefit that provides for the support of yourself and your dependents, and no more. In a Chapter 7, the rest of the benefit can be subject to seizure by the trustee. In a Chapter 13, the trustee can consider only the excess amount in drawing up a repayment plan.

Conclusion

While Social Security disability benefits are exempt according to the bankruptcy law, other types of disability benefits are only partially exempt. It's important to document the source of any disability benefits if you are preparing to file for bankruptcy, and fully disclose to the court any and all benefits you are receiving. Evasion of the disclosure rules can result in the court rejecting your bankruptcy petition, or dismissing your case if you already have one in progress.

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Are Term Vested Employee Deferred Benefit Plans Exempt in Bankruptcy?

References

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Are Personal Injury Payments Considered Income for the Bankruptcy Means Test?

When federal lawmakers rewrote the bankruptcy law in 2005, they set up a means test for debtors filing for Chapter 7 protection. The means test qualifies you for bankruptcy protection; if you don't meet the guidelines for Chapter 7, you can file instead for a Chapter 13 bankruptcy, which sets up a partial repayment plan. In the means test calculation, you may need to include lump-sum or structured settlement, or periodic, payments you receive from a personal injury lawsuit.

Does Your IRA Survive Bankruptcy?

When extreme financial hardship strikes, you have the option of filing for bankruptcy protection. Under Chapter 7 of the federal bankruptcy law, a court-appointed trustee seizes any of your assets that are "non-exempt," meaning the law does not protect them from seizure. There are several categories of exempt assets, including the funds you have in an Individual Retirement Account. Although federal and state laws vary with regard to the exemption limit, your IRA account will survive bankruptcy intact.

Bankruptcy Exemption Requirements

If your debts are out of control and you have little hope of catching up on the bills, you have the option to file for bankruptcy protection. The federal bankruptcy code allows you to file under Chapter 7 or Chapter 13 of the code. In a Chapter 7 bankruptcy filing, a court-appointed trustee seizes your non-exempt property to repay your debts. In a Chapter 13 filing, the trustee sets a repayment schedule, and you are allowed to keep your property. Exemptions are an important consideration in both forms of bankruptcy.

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