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Personal Bankruptcy

By Michael A. Webb, TGPC, AIF™, CEBS

In light of the recent Supreme Court decision in Clark v. Rameker, in which an inherited IRA was determined to be part of the bankruptcy estate and thus subject to creditor claims, some advisors may be questioning their understanding of personal bankruptcy and its effect on retirement plan assets. Are retirement plan assets subject to bankruptcy creditors? Does the answer to this question depend on the type of retirement plan or the type of bankruptcy? In this article, we will revisit the personal bankruptcy code’s effect on retirement plans. 

Personal Bankruptcy and Retirement Plan Assets

Unlike inherited IRAs, retirement plan assets, including 401(k), 403(b) and 457(b) plan assets, generally are not subject to the claims of creditors. Non-inherited IRAs are also excluded from the bankruptcy estate and not subject to the claims of creditors, but there is a $1 million dollar limit on the IRA exclusion (the limit is an aggregate limit for all IRAs owned by the debtor). These exemptions are the case regardless of whether the bankruptcy is a Chapter 7 liquidation or Chapter 13 reorganization, or whether or not the retirement plan is subject to ERISA. 

Section 457(f) ineligible deferred compensation plans, however, are not part of the Bankruptcy Code exemptions described above. Thus, depending on applicable law, such plans may be subject to the claims of creditors in the event of personal bankruptcy.

Practice Pointer: Though specific tax or legal advice should always be provided by an attorney or other applicable professional well versed in such issues, advisors can provide added value to both participants and plan sponsors by knowing the basics. Bankruptcies are often difficult situations where any useful information that is helpful in navigating the process can help to cement advisor relationships. 

What About Loans? 

Since debtors are relieved of most payment obligations in a bankruptcy, they often erroneously believe that they may cease payments on any outstanding retirement plan loans they have as well. However, this is not the case. Retirement plan loans are not considered to be a debt for bankruptcy purposes, and are not discharged (forgiven) in a bankruptcy proceeding. In fact, such loans are generally unaffected by a bankruptcy proceeding. Payments should continue to be made by a participant as scheduled, with the consequences of nonpayment (e.g., default) the same as for any other participant. 

Conversely, a debtor who does not have an outstanding loan from a retirement plan cannot be forced to take a loan (or take a permissible distribution) as part of any bankruptcy proceeding, This is the case even in the event of a Chapter 13 bankruptcy which generally requires that a debtor utilize all disposable income to repay creditors. Access to retirement plan assets in this fashion is not considered to be disposable income for Chapter 13 bankruptcy purposes. 

Conclusion

With limited exceptions (e.g., 457(f) plans), participants who have filed for Chapter 7 or Chapter 13 bankruptcy are no different than other retirement plan participants, despite the recent Supreme Court ruling. Of course, bankrupt participants may be more at-risk than other participants regarding accumulation of sufficient retirement savings, since the events that led to their bankruptcy have likely limited their ability to voluntarily contribute to their retirement plan and/or eroded their account balances through loans and distributions. 

Practice Pointer: If a number of participant bankruptcies have surfaced, working with the plan sponsor on educational opportunities for participants to ensure they can meet their financial goals, including goals for retirement savings, may be prudent... 

Michael Webb is the NTSAA Education Committee Chair and a Vice President at Cammack Retirement. 

Cammack Retirement is an independent retirement plan consulting firm specializing in non-profit industries.  Offering tailored, actionable solutions, to help clients achieve the greatest return on their employee investment, Cammack Retirement delivers end-to-end solutions for complex retirement plan challenges.
 
Please note that this article is for general informational purposes only, is not intended to be taken as legal advice or a recommended course of action in any given situation. Readers should consult their own legal advisor before taking any actions suggested in this article.