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How does bankruptcy affect your retirement accounts?

Several years ago, a study by the U.S. Courts Administrative Office found a gradual aging of those filing for bankruptcy. For those considering bankruptcy in middle age, there may be concerns about whether bankruptcy means retirement must be postponed.

Most understand that Chapter 7 bankruptcy discharges credit card debt, medical bills and can offer a fresh financial start. Even today it is a common misperception that an individual loses everything he or she has in the process. That is simply not the case.

Assuming an individual meets the means test to qualify for Chapter 7, your bankruptcy counsel must next consider whether you have any assets that you cannot exempt, or protect, from the reach of the bankruptcy trustee. Before you decide to file your case, the question is whether you will lose anything in chapter 7. Generally creditors receive the proceeds from the sale of all non-exempt assets in those few cases where some things are not exempt. Following the trustee sale, most remaining debts are forgiven without the need of a payment plan.

Exempt versus non-exempt property

Your bankruptcy attorney classifies property as exempt or non-exempt based on federal and state laws after an itemized account of assets is established. How does this affect retirement accounts?

The general rule is that employer-provided retirement accounts (i.e. pensions, some stock bonuses and profit-sharing, and 401(k) accounts) are exempt. Any of those pre-tax direct debits from a paycheck put into an account to fund retirement generally cannot be liquidated in a bankruptcy. The same is true of IRAs up to a very high limit.

Does an Individual Retirement Account (IRA) rollover make a difference? Few people spend their entire career with one company anymore. Often it makes sense to rollover retirement accounts from past employers into one IRA. This does not generally affect the treatment and the account assets remain protected.

The retirement savings exemption generally also applies to after-tax Roth IRA accounts. The bankruptcy court will however look at the balance of the accounts when deciding exempt status. If the accounts contain considerable assets, there is the chance they could exceed the maximum and that a portion may be classified non-exempt.

Loans taken out against a retirement account are also treated differently than a typical loan. Chapter 7 will not discharge these loans.

Be careful though as transfers of retirement account assets to a checking or savings account often means that the assets lose their protected status.

Homestead exemption

Another part of retirement savings is the equity built up in a home. Connecticut allows a homestead exemption of up to $75,000 in personal bankruptcy. Yet the protection does not extend to the proceeds of a voluntary sale. This is similar to cashing out a retirement account and losing the protected status of the asset.

If you are a small-business owner or an individual struggling with mounting debts, contact a Connecticut bankruptcy attorney to discuss available options. Chapter 7 bankruptcy relief provides relief from creditors and may still allow you to retire as planned.