Chapter 7 Bankruptcy And Pension Benefits: What You Need To Know About Exemptions
Before you file for chapter 7 bankruptcy, it's important to understand what could happen to your assets. While a chapter 7 bankruptcy is sometimes an effective way to write off uncontrollable debt, you may regret your decision to proceed in this way if the action damages your long-term retirement plans. Find out if a chapter 7 bankruptcy action could affect your pension, and learn more about the exemptions you can apply for to protect these financial assets.
How legislation changed
In 2005, the U.S. government introduced new legislation that aimed to make it harder for people to protect their assets as part of a bankruptcy application. At the time, legislators believed that it was too easy for consumers to file for bankruptcy without repercussions, and the legal changes meant that this action was no longer as attractive for some people. In the longer term, the changes aimed to force people to take more responsibility for their finances.
As part of this act, consumers actually benefited from MORE protection in a few areas, including pension funds. Recognizing that a good pension fund was, in fact, a sign of good financial management, the 2005 legislation stopped creditors getting access to most types of pension when calculating the value of a bankruptcy estate.
Pension funds that cannot form part of a bankruptcy estate
The 2005 law change protects many pensions, but it's still important to check which investments are protected.
Retirement accounts that cannot form part of a bankruptcy estate include:
- Individual Retirement Accounts (IRAs) under IRC 530 (1)(b) – subject to some limitations (normally up to $1 million or another value determined by the court)
- Pension and retirement plans that fall under the Employee Retirement Income Security Act (ERISA)
- Government retirement plans under IRC 414(d)
Many other types of pension funds are also subject to protection, but you cannot assume all these investments are safe. For example, the law does NOT protect Employee Stock Purchase Plans.
State and federal exemptions
As part of a bankruptcy application, you must decide if you want to claim state or federal exemptions. In some cases, you can claim both.
You should always check with a qualified bankruptcy attorney which exemption you should claim. The decision is often subject to several complex criteria. For example, some pensions can benefit from special protections if they are state employee retirement plans. Similarly, in some cases, federal exemptions often allow you to protect a larger share of the fund.
For example, a federal exemption will often also apply to payments (such as annuities or profit sharing) that you receive from your pension. By carefully considering how you can apply the exemptions, you could save an even larger share of your pension – and possibly the full value.
Wildcard exemptions and pension funds
If some (or all) of your pension is not exempt under state or federal exemptions, there is another way you can sometimes protect the asset.
Many states have a "wildcard exemption" that you can ask the court to apply to any asset that the creditors could otherwise take as part of your bankruptcy estate. The way these wildcard exemptions work can vary from one state to another. Some states simply allow you to apply the value of any other unused exemption to another asset. Other states simply allow you to claim a certain value. For example, in Illinois, you can simply apply your wildcard exemption to $4,000 of personal property.
You can also take advantage of a federal wildcard exemption. This allows you to protect $1,225 of personal property, plus up to $11,500 of homestead exemption that you haven't already claimed. Not all states allow you to claim federal and state wildcard exemptions.
It's important to understand how a chapter 7 bankruptcy application could affect your retirement investments. State and federal laws are generally complex, so it's always a good idea to contact a bankruptcy attorney, like those at Wiesner & Frackowiak, LC, for more advice.