In almost every situation, your retirement is protected in bankruptcy. It's often not even considered part of your "bankruptcy estate," and therefore totally out of the reach of your creditors and the bankruptcy trustee. It's also exempt through tough federal and California exemptions, both of which have been strengthen in recent years.
Retirement Accounts Which Are Not Even an "Assets of Your Bankruptcy Estate"
The first layer of protection makes many types of retirement plans off limits for creditors right out of the gate by considering them not even to be part of your "bankruptcy estate."
Under bankruptcy law (see Section 541(a) of the Bankruptcy Code), virtually everything you own is considered part of your "bankruptcy estate." Then, much of what is in your "estate" is protected by federal and California "exemptions." However, Congress has selected a few very special types of property to protect even further by legally excluding them altogether from being part of your bankruptcy estate. Excluded are contributions to most conventional employer-based retirement plans, deferred compensation plans, and tax-deferred annuities. (See Section 541(b)(7) ). These kinds of retirement plan are out of the reach of the creditors in the strongest way possible.
In the same way, excluded from your "estate" are retirement plans which are set up as trusts-as most retirement plans are, with your money being held in trust on your behalf. Those trusts are virtually always set up with language that specifically puts them beyond the reach of creditors, and bankruptcy law makes that even clearer. (See Section 541(c)(2) ).
What are NOT excluded from your bankruptcy estate under this trust-based law are the unusual plans which are set up as a trust by a single person and funded by the same person, who also retains full control over the trust. These would likely not be protected in bankruptcy.
California Allows the Use of Some Important Federal Exemptions
We need to start this section with a bit of background about state and federal exemptions. The Bankruptcy Code contains a list of "federal exemptions," plus each state has its own list of exemptions applicable to bankruptcies filed in that state. Federal law allows each state to decide whether debtors filing bankruptcy can use either the state and federal exemptions, or only the state ones. California has chosen to allow the use of only the California exemptions.
Nevertheless, there are some "non-bankruptcy federal exemptions" that ARE available to California residents, including some very important ones related to retirement plans. When we refer here to the "federal exemptions," it's to these ones which are available to everybody filing bankruptcy throughout the country.
Retirement Accounts Protected Through Federal Exemptions
The major overhaul of the bankruptcy laws in 2005 mostly did not help debtors, EXCEPT with the protection of retirement funds. Under the new law, virtually all retirement and pension funds are exempt from creditors, even if you live in a state such as California with the exemption scheme just described above. (See Section 522(b)(3)(C) .)
The exemption amounts are unlimited for most types of retirement plans, so the entire amount of the retirement account is fully protected. These include any ERISA-qualified pension plan, including 401(k)s, 403(b)s, Keoghs, profit sharing plans, stock bonus plans, employee annuities, government deferred compensation plans, money purchase plans, and defined-benefit plans.
There is a limit to the exemption for traditional and Roth IRAs, but it's at the relatively high amount of $1,171,650 per person (which is adjusted every 3 years).
In addition, there are a series of other retirement-related federal exemptions available to California residents that may apply to you. Most importantly, these include Social Security and veteran's benefits. Also exempt are the retirement benefits of Civil Service, Foreign Service, and military service employees, and railroad workers. There is also an exemption for military survivor's benefits.
Retirement Accounts Protected Through California Exemptions
With all this protection, why would you even need an additional layer of California exemptions? In most situations you might not. To some extent these various protections are redundant. But California's exemptions are broader in some respects, and so can still make all the difference in certain situations.
For example, although the funds sitting in your retirement accounts are usually exempt from creditors, retirement benefits that are paid to you as income may in some situations not be exempt under the federal exemptions. California Code of Civil Procedure 704.115 absolutely protects retirement income (not just the money sitting in a retiree's fund) from the reach of creditors.
The California exemption also continues to protect the money after you receive it, which can be very important because bankruptcy law is otherwise very stingy about allowing you to have any meaningful amount of cash when you file bankruptcy. The Code of Civil Procedure 704.115 (b) and (d) say:
(b) All amounts held, controlled, or in process of distribution by a private retirement plan, for the payment of benefits as an annuity, pension, retirement allowance, disability payment, or death benefit from a private retirement plan are exempt.
(d) After payment, the amounts described in subdivision (b) and all contributions and interest thereon returned to any member of a private retirement plan are exempt.
As a result, as long as you can trace the income in the separate account to the retirement plan, such funds are exempt and yours to keep in bankruptcy.
With all these layers of protection, your retirement account should be exempt and untouchable in bankruptcy in almost every situation. Only in the unusual case-such as if your retirement plan is not really a retirement plan, or one that was created as in improper tax shelter, or for some other inappropriate purpose-might you have a problem.
Nevertheless, the law can still get complicated and potentially dangerous, even in completely innocent circumstances, such as if you've had a rollovers of plans when you've changed jobs, made any irregular contributions to or withdrawals, or have borrowed against your retirement. There is no question: with something as valuable as your retirement, discuss your unique situation with an experienced bankruptcy attorney to put the strong protections of the law to work for you.