Many people worry about how their retirement savings will be affected by bankruptcy. There are basically 3 issues here:
- Will I lose my retirement savings or pension benefits that I have already earned when I file bankruptcy?
- Will I be penalized if I just started saving for retirement or increased the amount I am saving for retirement right before filing bankruptcy?
- Will I be allowed to continue to save for retirement during my bankruptcy case?
The good news is that you won’t lose your already earned benefits, it is fine if you just started saving for retirement or increased your retirement savings rate just prior to filing bankruptcy, and contributions to retirement savings are allowed during the pendency of either a Chapter 7 or Chapter 13 bankruptcy.
Saving for Retirement
So, there’s really not much bad news when it comes to retirement. But, to expound a bit, understand that our public policy in general is to encourage people to save money for retirement. For everyone, not just those filing bankruptcy, there are incentives to save: tax savings, reduction of your Adjusted Gross Income that will allow you to qualify for other benefits (like the recent CARES Act Covid-19 stimulus and child tax credits), incentives for employers to match your contributions, etc.
Then, in addition to those benefits, people who are contemplating bankruptcy get the added benefit of keeping all of their retirement savings that are held in an ERISA qualified retirement plan. There are very limited exemptions for cash or money in a regular bank account to allow a person filing bankruptcy to retain those funds. But, in every state, there is an unlimited exemption for money in an ERISA-qualified retirement account. Here’s an example: let’s say you are a Kansas resident, and you file bankruptcy with $1,500 in your checking account and $5 million in your 401(k) at work. The trustee will make your turn over that $1,500 that was in your checking account on the day of filing. But, the $5 million in your 401(k) account? Yours to keep. Seems crazy, but it is true.
Chapter 7 & Chapter 13
In both the Chapter 7 and Chapter 13 means testing, involuntary retirement plan contributions (think union or government pension plans) are counted as deductions from income. In Chapter 13 cases, voluntary retirement plan deductions (think 401(k) or 403(b) retirement plans) are also allowed as deductions from income. In Chapter 13 cases, the means test relies on your earnings from the past 6 months to determine your income, but your deductions from income are based on expected expenses. What that means is that if you increased your 401(k) plan contributions from say 5% to 12% of your income shortly before filing, then you get to take that 12% contribution as a deduction. Now, there are good faith limits to that – you can’t just up your contributions a week or two before filing and expect no one will object to that. But, if you increased those contributions a couple of months before filing, then there is a really good chance that the increased contribution will be allowed as a deduction.
What about increasing your 401(k) contribution while your bankruptcy is still going on? Is that going to cause a problem? Is it even allowed? The answer is not only “yes”, but it is encouraged. If you are willing to put money away for retirement, the laws are designed so that you benefit tremendously.
If you need advice regarding your financial situation, please contact our office at 913-422-0909.