In a chapter 7 bankruptcy, there are both dischargeable and non-dischargeable debts. Likewise, there are assets that can and cannot be seized to satisfy creditors. An asset that frequently causes consternation among chapter 7 filers is the traditional retirement account. Whether it is a 401(k) or an IRA, people are not sure where their retirement accounts stand should they need to file bankruptcy.
In this post, we will clear up the confusion related to chapter 7 bankruptcy and retirement accounts. As always, if you are facing financial problems that could lead to bankruptcy, we encourage you to contact us. We can discuss your case with you and advise you as to the best course of action.
Retirement Accounts Owned by the Filer
In April to 2005, Congress passed what is known as the Bankruptcy Abuse Prevention and Consumer Protection Act; then-president George Bush signed the legislation shortly after it made its way through Congress. The legislation resulted in several significant changes to U.S. bankruptcy law, including the protection of retirement accounts owned by chapter 7 filers. Simply put, anyone who files a chapter 7 bankruptcy and owns one or more individual retirement accounts or 401(k) accounts at the time of filing can rest comfortably that those accounts cannot be seized to pay creditors.
There is one exception to this protection: a limit on the amount of money that can be kept by the filer. Individuals can now keep as much is $1.2 million in their retirement accounts even in the midst of chapter 7 bankruptcy. Anything over and above that amount is subject to seizure.
Retirement Accounts Inherited by the Filer
Despite the protections afforded retirement accounts with the 2005 legislation, there was some disagreement within the U.S. Bankruptcy Court about how to handle inherited retirement accounts. The turning point came in 2014 in the Clark v. Rameker case. The Supreme Court ruled in Clark v. Rameker that inherited retirement accounts were not protected because:
- Filers who inherited them were legally barred from making additional contributions;
- They are required to take distributions from the accounts regardless of age; and
- They can withdraw cash from said accounts at any time, and for any reason, without penalty.
These conditions led the court to conclude that inherited retirement accounts were no longer genuine retirement accounts. Instead, they were cash assets left to beneficiaries in the event of the original account holder’s death.
Again, there is one exception to the court’s ruling: retirement accounts inherited by surviving spouses. Should a surviving spouse inherit a retirement account and then declare chapter 7 bankruptcy, that spouse is afforded the protection. As an added bonus, the $1.2 million limit on IRAs does not apply to 401(k) accounts. There is no upper limit for the 401(k).
You should note that states are allowed to establish their own exemptions for assets that can be
seized in a chapter 7 filing. Some states offer full protection for all retirement accounts, whether inherited or not. Illinois is not one of them. Should you inherit a retirement account and then file for bankruptcy here, that money will be exposed.
The risk of exposing inherited retirement money is yet another reason bankruptcy is not always the best option. It also underscores why it is so important to consult with an experienced bankruptcy attorney before making any decision. If you have questions about bankruptcy, please do not hesitate to contact us and speak with one of our bankruptcy specialists.