Are Term Vested Employee Deferred Benefit Plans Exempt in Bankruptcy?

by Tom Streissguth
Qualified pensions are kept out of the bankruptcy estate by federal law.

Qualified pensions are kept out of the bankruptcy estate by federal law.

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Bankruptcy can wipe the debt slate clean, but it can also result in loss of property to a court-appointed trustee. If your company rewards work and loyalty with a pension plan, you may be able to protect some or all of that asset from seizure in bankruptcy. It all depends on whether the plan meets certain qualifying guidelines; even if the plan does not qualify, it may be possible to exempt at least a portion of it under either federal or state exemptions.

Bankruptcy Chapters

A debtor filing for bankruptcy requests protection by a court from collections, judgments and creditor lawsuits. In a Chapter 7 bankruptcy, a trustee will seize non-exempt property for the repayment of creditors. In Chapter 13, the debtor repays a portion of his debts to creditors through a three- to five-year plan set up by the trustee; no property is seized.

Exemptions

The federal law governing bankruptcy establishes property exempt from seizure in Chapter 7 bankruptcies. Individual states have their own exemption schedules; some states allow debtors to choose between federal and state schedules, while others require the use of the state schedule. For a Chapter 13 bankruptcy, a trustee may only consider "disposable" assets available when drawing up a repayment plan. The debtor can protect exempt assets and income from inclusion in the plan.

Pensions and Vesting

Companies that offer pension plans may do so on a "term-vested" or "deferred benefit" basis. This means the employee must work a minimum length of time to be entitled to the entire pension balance -- the benefit is deferred until the plan is fully vested. If a debtor with a term-vested pension plan files for bankruptcy, he may be able to exempt a portion, or all, of the plan assets, depending on whether the plan meets certain guidelines.

ERISA Plans and the Law

An important Supreme Court decision in 1992 covered employer-provided plans that meet qualifications of the Employee Retirement Income Security Act of 1974. These ERISA-qualified plans are not considered a part of the bankruptcy estate -- the property that is available to the trustee in a Chapter 7 or Chapter 13 bankruptcy. Therefore, technically, there is no need to claim such a plan under a schedule of exemptions.

Other Protected Plans

Other plans that can be held out of the bankruptcy estate include 401, 403 or 408 tax-exempt retirement plans, some government pensions, plans that feature deferred compensation, and retirement plans offered by churches, governments or any other tax-exempt organization. Whether or not these plans require term-vesting, they're not available to a bankruptcy trustee.

Non-Qualified Plans

Certain plans don't qualify for bankruptcy exemptions at all, whether or not they're term-vested plans. These include employee stock purchase plans, inherited IRAs, plans not conforming to pension guidelines set by the Internal Revenue Service, and deferred compensation plans. Nevertheless, a debtor may claim a portion of a non-qualifying retirement plan as necessary to meet essential personal expenses, or use a "wildcard" exemption, which allows the protection of any kind of property up to a certain dollar amount.