The decision to file personal bankruptcy can inspire a lot of questions about your finances. While a fresh start may be necessary, will the process divest you of your savings and retirement accounts? What happens to your 401(k) account? These are essential questions that need to be resolved before you can make an informed decision about your situation and how to proceed. 

The court will protect a 401(k) and other qualified retirement accounts (such as IRAs) during bankruptcy in almost every case. Therefore, if you are tempted to cash in these accounts to deal with debt, you may want to think twice. Federal law protects your 401{k) from creditors, but the trustee will use cash on hand to pay debts. 

Here is a short description of bankruptcy law. 

How Bankruptcy Impacts Your 401(k)

There are differences between how Chapter 7 and Chapter 13 bankruptcy deal with your debt, but both solutions allow you to keep your 401(k). 

Chapter 7: According to federal law, tax-exempt retirement accounts are considered exempt in the bankruptcy process, regardless of whether state or federal bankruptcy exemptions are used. There are many types of accounts besides 401(k)s covered by this protection, including 403(b)s, profit-sharing, IRAs, and defined-benefit plans. In all cases except one, the exemption amount is unlimited — which means an individual can exempt the entire account. The sole exception applies to traditional and Roth IRAs, which are eligible for exemption up to $1,362,800 combined.

Chapter 13:  In Chapter 13 bankruptcy, your property remains with you. Therefore your 401(k), IRAs, and other tax-exempt retirement accounts are protected in the process.

Your 401(k) – What NOT to Do

When someone learns that their 401(k) is safe, it may cause a false sense of security. There are still ways to jeopardize your retirement savings, so here is the professional advice you need to keep your money protected – and to make sure it is there when you need it. 

Never Cash In Your 401(k): You may think using your retirement funds to pay off overdue bills is a good idea. However, when you withdraw money out of your 401(k) and deposit the funds into another account, the funds and your 401 (k) lose exempt status.

Don’t Try to Put Off the Inevitable: Liquidating a 401(k) to settle other financial debts is rarely a good idea. First, you will pay penalties and fees for early withdrawal, so money is needlessly lost. Not only that, but you will be using money that would be otherwise protected to pay off debts that are likely to be discharged in the bankruptcy process. If filing for bankruptcy is on the table, keep your retirement savings in the bank. Those drowning in financial debt can rarely correct their situation unless something significant occurs, so putting off the inevitable may worsen the situation.

Don’t Move Your Money Around: Those researching a possible bankruptcy may decide that switching non-exempt cash into an exempt asset before filing can save its value. But you should never move money around before a bankruptcy without speaking to a bankruptcy attorney. If the trustee has reason to think that you transferred any property to defraud or shortchange a creditor, the property could lose its exempt status. Even worse, if the court determines that you engaged in any fraudulent activity, it can deny your case entirely and refuse to discharge your debts.

If you are considering bankruptcy, the time to call an attorney is now. Don’t wait until the last minute and make a mistake that will ultimately hurt your case. The attorneys at the Sarasota law offices of Richard V. Ellis are here to discuss your case and give you the guidance you need to get on the road to financial recovery.