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Retirement and Bankruptcy

If you are worried that bankruptcy will wipe out your retirement savings, the good news is that retirees often can keep their retirement savings even if they have substantial debt. This is because bankruptcy law exempts most retirement accounts from bankruptcy. 


While every state has its own bankruptcy code, California law often views social security benefits and retirement savings as not part of the traditional “bankruptcy estate,” which means that it is often possible to protect this income from creditors whether you file for Chapter 7 or Chapter 13 bankruptcy. This is in part because the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) specifically excludes Social Security income from the calculation of monthly income


California and Federal Bankruptcy Exemptions


Both state and federal bankruptcy exemptions exist. The Bankruptcy Code contains federal exemptions, but each state is also allowed its own list of exemptions that apply to bankruptcies filed in the state. Federal law allows each state to determine if people filing for bankruptcy can use either state and federal bankruptcy exemptions or if a person can only use state exemptions. In California, only state exemptions are used. This issue is made more complex, however, because there are some non-bankruptcy federal exemptions that California residents can claim when filing for bankruptcy. 


The Role of California Exemptions


Several bankruptcy exemptions in California protect senior citizen assets. Consider the following:


  • If a person earns a wage, California allows only a maximum of 25% of that individual’s tax paycheck to be garnished
  • Pension income cannot be levied, either before or after a retiree receives it
  • For individuals over 65, the California homestead exemption is $175,000


How Certain Retirement Assets are Handled During Bankruptcy


Consider the following about how certain assets are handled through the use of federal non-bankruptcy exemptions during the bankruptcy process:


  • Social security payments are safe in bankruptcy cases unless they are deposited into your bank account. 
  • Pensions are protected if they qualify under the Employment Retirement Income Security Act of 1974. Pensions plans are required to meet certain requirements to qualify for this program. Even though pensions from governments and non-profit organizations are not qualified for this act, they may still be exempt provided that they meet other Internal Revenue Code requirements.
  • 401(k) accounts are protected from bankruptcy under Section 401(k) of the Internal Revenue Code
  • It is currently possible to protect up to $1,283,025 in traditional or Roth IRAs. This maximum has increased every few years. 
  • The Internal Revenue Code protects certain annuities, based on the annuity’s funding. 


Filing for Bankruptcy can Impact Your Savings


While retirement funds in California are protected in Chapter 7 and Chapter 13 bankruptcy, it is important to realize that any withdrawn retirement benefits are not exempt from creditors. This is because these benefits are paid as income. If you are filing for Chapter 7 bankruptcy, these benefits can disrupt the means test because they will be factored into your monthly income. If you are filing for Chapter 13 bankruptcy, retirement income will play a role in determining the amount of your repayment plan.


Vacation Properties Might be Lost


If you were able to obtain a vacation home during your life, you will likely not be able to keep this property because it will not qualify for the homestead exemption. In California, a person can choose between System 1 and System 2 when selecting a homestead exemption. 


Under System 1, everyone who owns a home and lives in it is allowed a homestead exemption. For single homeowners, this equates to a $75,000 equity exemption. Under System 2, a homeowner is allowed to exempt up to $29,275 in home equity. California, however, does not allow people who file for bankruptcy to use the federal bankruptcy exemption.


While you might be able to keep your primary home, California bankruptcy law offers no protection to vacation homes or investment property. As a result, your trustee can sell this type of property if you file for Chapter 7 bankruptcy even if you would like to keep it. If you can file for Chapter 13 bankruptcy, you might not have to give up the property but it would play a role in influencing the amount of your repayment plan.


Do Not Use Retirement Accounts to Pay Off Debts


Some people attempt to pay off debts using money in IRAs or 401(k)s. This, however, is rarely a good idea because people often end up using protected assets to pay debts that could otherwise be eliminated through bankruptcy. If you are withdrawing assets from a 401(k) or IRA before turning the age of 59, you could end up facing substantial tax consequences. It is almost always better to utilize bankruptcy to discharge as much of these debts as possible. 


If you are filing for Chapter 7 bankruptcy, it can only discharge or erase certain types of debt like utility bills, credit card debts, and medical bills. Other amounts like car loans, liens, mortgages, and student loans cannot be erased through Chapter 7 bankruptcy. 


Contact a Knowledgeable Bankruptcy Lawyer


The coronavirus pandemic has caused many businesses to consider bankruptcy, but with the proper strategies, there is little to fear about the process. If you are a senior citizen or older individual who is facing medical bills, credit card bills, or any other type of debt, you have likely considered bankruptcy. Due to California and federal laws, however, it is often to protect many of the assets that an older individual owns. This means that even if creditors sue and win, they will not be able to collect much. If you are in such a situation, bankruptcy might not be a necessary option. 


The best way to decide if filing for bankruptcy is a good idea in this situation is to speak with a knowledgeable attorney. To schedule a free case evaluation with a knowledgeable bankruptcy lawyer today, contact attorney Melanie Tavare.

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