What Happens to a 401(k) in Bankruptcy?
- Chapter 13 bankruptcy is debt repayment bankruptcy. It is, in brief, a way to consolidate all your debts into a single monthly payment. The Chapter 13 bankruptcy process does not require you to sell or give up any of your property. Chapter 13 simply does not affect any of your assets, including your 401k retirement account.
- In a Chapter 7 bankruptcy, though, the bankruptcy court will appoint a trustee to seize and sell all your nonexempt property. The trustee uses the money to pay off your creditors. Any creditors left unpaid then lose their right to enforce the debt, and you walk away free and clear. There is often concern, then, that 401k retirement accounts might be affected in a Chapter 7 bankruptcy.
- When you file for bankruptcy, you create a permanent line in the sand regarding your assets and property. Any property that you own as of the date you file for bankruptcy is included as part of your bankruptcy estate. Any property that you acquire after filing for bankruptcy, even if you acquire it the next day, is not part of your estate. So, if you file for bankruptcy, and the next day you contribute $1,000 to your 401k, that $1,000 is not part of the bankruptcy estate.
- Technically, 401k retirement accounts are part of your bankruptcy estate. However, federal law and every state's laws provide a specific exemption for 401k retirement accounts. Bankruptcy trustees cannot under any circumstances seize or sell exempt property, which means your exempt 401k is fully protected. Plain and simple, you keep your 401k in full because you can claim an exemption for it.
- One complication that often arises in bankruptcy is the 401k loan. Many 401k plans allow you to borrow money from your 401k, and you pay that back over time, with interest. Your obligation to repay the 401k loan is not affected by bankruptcy. You will have to comply with the original loan agreement, regardless of whether you file Chapter 7 or Chapter 13.