Retirement accounts tend to be heavily shielded during bankruptcy. If the retirement account meets the standards of the Employee Retirement Income Security Act of 1974 (ERISA), it is generally shielded from bankruptcy. ERISA qualified retirement accounts cannot be seized to pay off your creditors, regardless of the balance. Voluntary retirement plans are not exempt from bankruptcy, such as a bank account you have designated as your retirement savings.
Retirement accounts held by a brokerage house designated by your employer but to which they make no contributions are not ERISA qualified. Deferred compensation plans are often used as a form of retirement savings, delaying compensation until someone retires and then paying them a lump sum at that time. However, deferred compensation is an asset that the bankruptcy court can claim and liquidate to pay creditors. It is not fair for you to hold off several years of income to be paid in the future when you owe money to creditors today.
Loans against a 401K or retirement account are not discharged by bankruptcy. If you have taken out a loan against your 401K retirement account, you will have to pay back that loan with interest or risk the account holdings being liquidated to pay off the loan. This creates a double-whammy for debtors who took a loan against their retirement account to forestall bankruptcy. Debtors will see the value of the retirement account drop as holdings are liquidated to pay the 401K loan. Then the debtor will be hit with a tax bill for the amount taken out to pay off the 401K loan. Because it counts as a withdrawal, borrowers will owe their full income tax rate on the loan payoff amount and a 10% early withdrawal penalty if they are younger than 59 1/2 or fully disabled.
Self-directed IRAs have grown in popularity due to the mistrust of large investing firms and the desire to profit from more exotic investments like commodities, gold, art and agricultural land. However, it is illegal to use the IRA to shield non-exempt property from seizure. For example, you cannot move your home into the IRA to protect it from foreclosure. Contributions to 401K plans will be stopped during bankruptcy proceedings to generate more cash to pay creditors.
You cannot shield money from seizure by placing it in a retirement account. For example, moving 5,000 dollars into each spouse’s IRA before filing for bankruptcy is considered bankruptcy fraud. Likewise, moving money into college savings plans for your children, suddenly contributing the maximum to your 401K or buying a retirement annuity with your remaining cash is also considered bankruptcy fraud. Hawaii allows the bankruptcy court to demand up to three years worth of retirement account contributions back to be used to pay creditors. However, Hawaii exemptions include an existing annuity contract for which the surviving spouse will be the beneficiary.
Pension plans are also shielded from bankruptcy. Hawaii bankruptcy specifically exempts from seizure firefighter pensions, police officer pensions and public employee pensions. Worker’s compensation paid to the disabled is also exempted in bankruptcy cases. If you are not certain if your retirement account or pension qualifies as exempt under Hawaii bankruptcy law, consult with a Honolulu bankruptcy lawyer.
While you can keep your 401K in almost all bankruptcy cases, you cannot take out a loan against your 401K without the bankruptcy court’s permission. If you cannot meet your basic living expenses under the bankruptcy court’s repayment plan, do not take out a new loan with tax implications. Instead speak with a Hawaii bankruptcy lawyer to adjust the payment plan to provide enough money to live upon.