Most employees usually have an IRA, that is, an individual retirement account coupled with a 401(k). A 401(k) account is sponsored by an employer who matches your contribution to the account with a certain sum, say 50% of your contributions to the account. On the other hand, an IRA is individually managed and arranged with an investment firm. Here, the employer of the account holder does not contribute to the funding of the account.
A retirement account bodes many benefits to you. It would see your current taxable income reduced, improve your spending habits, and provide a safe financial haven for you during retirement.
Managing your bankruptcy plan alongside your retirement accounts can be a little tricky. You’d like to leave as much money in it as you can. The time to hang up your work boots may not be so far away either. That makes it imperative that you settle your debts as quickly as possible.
There’s a range of bankruptcy options to choose from. And each comes with its different benefits and consequences for a debtor. Choosing Chapter 13 would most times be the best as it’d help preserve any real estate you have so you don’t have to pay rent from a retirement plan if you can avoid it.
For a quick explanation, Chapter 13 bankruptcy filing is a procedure where you undertake to pay up your debts within a period of three to five years under a plan approved by a bankruptcy court. It is commenced by filing the bankruptcy forms and attaching documents such as a statement of your current and estimated future income, a list of your creditors, and the details of their claims against you in addition to documentation of the personal property.
So What Happens To Your IRA & 401K After Filing Chapter 13?
When you file for bankruptcy under Chapter 13, you make a pledge to pay off your debts between the next three to five years. After your plan is approved, the court then appoints an impartial trustee whose job is to oversee the payment of a portion of your wages to your creditors. You may be worried about whether this arrangement will result in the deduction of money from your individual retirement account or your 401K. The answer is no, although there’s an exception to this rule.
In 2005, the United States Congress made some alterations to the Bankruptcy Code. The new provision stated that retirement accounts listed under the Employee Retirement Income Security Act (ERISA) will no longer be used to pay creditors under a bankruptcy plan. They include money-sharing accounts, profit-sharing plans, 403(k) accounts, individual retirement accounts, and 401(k) accounts.
This means that both your 401K and IRA are protected. But as earlier hinted, there is an exception. Once the amount of money in the combination of your retirement accounts exceeds $1,362,800, the excess can be used to pay your debts in line with your Chapter 13 plan. The idea is that the specified sum is deemed sufficient to provide a reasonable living standard, hence the excess can be used to settle the debts owed to creditors.
Chapter 13 And 401K Loans
A 401K loan isn’t like every other loan. It is a bulk withdrawal made on your retirement account. Sometimes you could have need of immediate cash to settle an urgent financial obligation or fund an important project. Depending on the structure of the 401k account, you may be allowed to take a part of the money in your retirement account. The IRS permits a deduction of $10,000 dollars or 50% of the total balance, provided the sum is not above $50,000.
We already know that under the bankruptcy code, 401k accounts are exempted from being claimed by creditors to settle outstanding loans but taking loans from your 401k has an effect on your ability to pay back your debts. These loans also come with stern penalties and tax consequences. It is therefore better to consider all your options before taking a loan on your 401k. If the loans are paid off during the time you are in Chapter 13 then your payments would increase by the loan payment amount when each one is paid off.
Will You Still Be Able To Make Contributions To Your IRA And 401K After Filing Under Chapter 13?
Yes. The Sixth Circuit recently issued an opinion in IN RE DAVIS decided June 1, 2020, that if you were contributing to your 401k for six months prior to the bankruptcy and the plan was proposed in good faith then you can continue to make the voluntary contributions and the amount is not considered disposable income. However, you would not be able to start making contributions just to lower the amount that you have to pay your creditors.
Does Withdrawal From Your Retirement Account Affect Chapter 13 Filing?
This boils down to the time when the withdrawal was made. For instance, if you made the withdrawal three years before filing for Chapter 13 bankruptcy, you will not necessarily be penalized. The same is not the case when you made a withdrawal from your retirement account a few months before filing. Here, you stand a good chance of losing the protection offered under the bankruptcy code.
Some people might be tempted to quickly remove money from their regular account and deposit into an IRA before filing for Chapter 13 bankruptcy. They fail to realize that filing Chapter 13 does not result in an automatic discharge of your financial obligations. The court will have to look at your plan and financial statements before approval. An indication that you just transferred a significant sum to your IRA can be a sign of bad faith. In such a case, your application may be dismissed, leaving you in a lurch as you would have to wait for a period of six months before making another application.
Final Notes.
Choosing to restructure your debts under Chapter 13 bankruptcy will not necessarily impact your 401k and individual retirement account. Where the balance in these accounts taken together is not in excess of $1,362,800, you’ll be allowed to keep all of your retirement cash. However, should you plan to make contributions to your income to the account, it is best to consult your local bankruptcy attorney.
About the Author: Roxane Kaye, has been practicing law since 2002. She is admitted to practice law in Michigan state courts and before the Federal Bankruptcy Court of Eastern Michigan, Southern Division, as well as the Federal District Court of the Eastern District of Michigan. Roxane covers cities such as Burton, MI, Flint, MI, Fenton, MI, Beecher, MI, Lapeer, MI, Waterford, MI, Auburn Hills, MI, Pontiac, MI, Howell, MI, Owosso, MI, Wixom, MI, Rochester, MI, Rochester Hills, MI, Novi, MI, and South Lyon, MI.
You may contact Roxane below:
Roxane M. Kaye
Kaye Law Office, PLLC
8161 S Saginaw St
Grand Blanc, MI 48439
