If you file for Chapter 7 or Chapter 13 bankruptcy, what happens to your 401(k) account? For the most part, your 401(k) and other qualified retirement accounts are safe, you will not lose them in the bankruptcy. Because federal law protects these accounts from creditors and the bankruptcy trustee, cashing in a 401(k) to deal with debt is almost always a bad idea.
Chapter 7 vs. Chapter 13 Bankruptcy
There are two main chapters of bankruptcy used by consumers. Chapter 7 and Chapter 13.
In Chapter 7 bankruptcy, you eliminate most or all of your debt, but in return must turn over nonexempt property to the bankruptcy trustee, who sells it and uses the proceeds to pay your creditors. Any property that is exempt through state or federal law is protected, and cannot be taken by the bankruptcy trustee.
In Chapter 13 bankruptcy, you keep your property and pay off some or all of your debts through a three to five year repayment plan.
There are a variety of other significant differences between Chapter 7 and Chapter 13 bankruptcy, and not everyone is permitted to file for Chapter 7.
Retirement Accounts Are Exempt Property
Congress overhauled the bankruptcy laws in 2005. Under the new law, virtually all retirement account and pension plan funds are exempt from creditors, meaning you get to keep them if you file for Chapter 7 bankruptcy. In Chapter 13 bankruptcy, because your retirement accounts are exempt, they will not affect how much you must repay unsecured creditors.
With a few exceptions, the exemption amounts are unlimited, so the entire amount of the retirement account is protected. Plans subject to this exemption include any ERISA-qualified pension plan, such as:
• Profit-sharing plans
• Money purchase plans
• Defined-benefit plans
In general, the bankruptcy courts understand that the goal of the bankruptcy process is not to punish people, but rather to provide a fresh start from which they can succeed financially. Individuals who have questions or concerns about whether they will be able to retain specific assets and personal items are advised to discuss their situation with a bankruptcy attorney.
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