Retirement assets should not be used to avoid bankruptcy

Written by Harold Jarnicki on . Posted in Uncategorized

Financial problems can spring up virtually any time in life for a multitude of reasons. Some people may experience a medical emergency, leading to expensive medical bills. In these tough economic times, others may turn to credit cards as a means of financing their day-to-day expenses, leaving them with thousands of dollars in high interest debt. Still others may have lost their job and be unable to keep up with their mortgage.

Faced with these high bills, it is only natural that some people may look to other means of repaying them. Some may turn to their retirement accounts such as 401(k)s, IRAs, pensions, or annuities as a source of funds to help stave off bankruptcy. Although such a decision is often justified with good intentions, in reality those who do this are making their financial situation worse in most cases.

First of all, when a person withdraws retirement funds, he or she will have to pay taxes on the money withdrawn. By creating a tax liability on top of the debt owed, this only compounds a difficult debt situation.

Also, there is no reason to raid the retirement accounts before filing bankruptcy, because many of such accounts are exempt under the bankruptcy code. This means that the assets in these accounts cannot be used to pay off creditors. Accounts that are exempt in bankruptcy include:

  • Certain Individual Retirement Accounts (IRAs) (up to certain limitations)
  • Government Retirement Accounts
  • Deferred Compensation Plans
  • Pension and Retirement Plans Under ERISA (e.g. 401(k))
  • Tax Deferred Annuities
  • Profit-Sharing or Defined-Benefit Plans

Since such accounts are exempt, once the bankruptcy has been completed, the individual gets to keep the money that he or she had accumulated in the account before the bankruptcy.

If you are considering filing for bankruptcy, it is not a good idea to transfer your remaining assets to your retirement accounts to attempt to keep them away from your creditors. Once the bankruptcy petition is filed, a bankruptcy court will examine your prior transactions. If it finds that you transferred the funds to avoid losing them in bankruptcy, the account that it was transferred to can lose its exempt status and be used to satisfy some of your debts.

If you are experiencing financial difficulties, it is important to speak with an experienced bankruptcy attorney early in the process. An attorney can advise you on your debt relief options, how each would affect your assets and which one would be best for your situation.