Bankruptcy & Cashing in Retirement After a Discharge

By Kevin Owen

If economic circumstances force you to seek bankruptcy protection, you may be concerned about whether you will be forced to give over your retirement savings to your creditors. In most situations, your retirement accounts are protected during bankruptcy proceedings and after the discharge of your case. You may, however, suffer tax penalties if you cash out your retirement accounts after your bankruptcy if you are not at least 59 1/2 years old at the time.

Investment Accounts During Bankruptcy

When you file for bankruptcy, either liquidating your assets under Chapter 7 or agreeing to a repayment plan under Chapter 13, the court assesses what property can be used to pay your debts. Your checking, savings, mutual funds and brokerage accounts are all included in your bankruptcy estate and increase the overall amount you will pay to your lenders.

Retirement Account Exemptions

Retirement accounts, however, are treated differently. IRA, 401(k), 403(c) and traditional pension accounts may not be seized by the bankruptcy trustee in a Chapter 7 case as the funds are exempted by the Employee Retirement Income Security Act (ERISA). If you filed under Chapter 13, your retirement account balances may not be used to calculate your monthly payments so long as the money is deposited into a qualified retirement account. However, if you start withdrawing funds from your retirement account while your case is still pending, the money disbursed from your retirement account is not exempt and may be included in your bankruptcy to pay your lenders.

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Property Seizure After Bankruptcy

In Chapter 7 bankruptcy cases, a trustee can seek permission from the court to reopen the case after it is closed and your debts are discharged in order to seize more property from you. Although this may seem unfair, the courts allow this practice if the trustee is able to show you failed to disclose all of your non-exempt assets at the beginning of your case. However, the trustee is not permitted to seek to reopen your bankruptcy simply because you elect to withdraw from your retirement account after you receive your discharge.

Tax Penalties

One reason retirement accounts are so beneficial to investors is that the Internal Revenue Service gives them preferential tax treatment so long as you do not disburse the funds before you reach age 59 1/2. The IRS will impose a 10 percent early withdrawal penalty in addition to your standard income tax rate, on any funds that are cashed out before retirement age. Although you may feel that you need the funds at the time you emerge from bankruptcy, touching the money too soon may be a bad financial decision.

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Do You Lose Your 401(k) if You Go Bankrupt?
 

References

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