Don’t lose retirement in bankruptcy. If you have a standard kind of retirement account, like a IRA, 401K, 403b account, it is almost certainly protected in both Chapter 7 and Chapter 13 bankruptcy.
Unfortunately, many people do end up losing their retirement accounts. This can be avoided by proper planning and knowing what to do, and what not to do, with your retirement funds.
Loss of Retirement Account Due to Poor Planning
Not thinking ahead is the number one way people end up losing their retirement accounts in bankruptcy. More specifically, they don’t lose the retirement account itself. They take the money out of the retirement account first, then then they file bankruptcy.
This is understandable, but the problem can be avoided. This situation happens mainly when you want to avoid filing bankruptcy. Your plan is to use the retirement funds to pay down debt to a manageable amount, which you think you will be able to handle.
What happens next? You get hit with the taxes. Seems that they never withhold enough tax, so you end up with a big tax bill the following years. Then you have another bill you can’t pay. And, this bill is not dischargeable in bankruptcy.
Or, you get hit with an unexpected expense. The strategy of using your retirement to avoid bankruptcy works, if everything goes “just right.” You might even have had enough taxes taken out of the retirement to avoid a tax hit. (this significantly reduces the amount of money you actually receive, often as much as 40% is lost!)
When you get the unexpected expense, you may need to file bankruptcy. Of course, taking money out of your retirement before filing bankruptcy does not keep you from being able to file. It’s just sad, heartbreaking actually, when you realize you have depleted your retirement to avoid bankruptcy. You used it to pay bills you could have wiped out in the bankruptcy, so, you lose retirement in bankruptcy.