Is My Retirement Account Safe in Chapter 7 Bankruptcy?

A tax-qualified retirement account such as a 401(k), 403(b), or Simple IRA is generally “safe” in Chapter 7 bankruptcy.

Safe, in the Chapter 7 bankruptcy context, means that the retirement account is safe from seizure and liquidation by the Chapter 7 Bankruptcy Trustee assigned to your case. However, a little-used provision of the US Bankruptcy Code can provide a Chapter 7 Trustee the authority to claw back contributions you’ve recently made to your retirement accounts.

This Article will discuss the exemption, or protection, of retirement accounts in Chapter 7 bankruptcy generally and the one mechanism with which a Chapter 7 Trustee can access those funds.

First, why would anyone need to worry about a retirement account in Chapter 7 bankruptcy at all?

 

Chapter 7 Bankruptcy: Retirement Accounts and Asset Liquidation

 

A Chapter 7 bankruptcy is a “liquidation” bankruptcy. That is, in exchange for the governmental benefit that is the complete discharge of your debt without need for repayment, certain assets or valuable property may be seized and sold. The proceeds from such seizure and sale are paid to your creditors. After the  Chapter 7 Trustee takes his or her cut, that is.

The Chapter 7 Trustee is the individual assigned to your case by the Bankruptcy Court to perform this task. He or she is chartered by the US Trustee’s Office, a division of the US Department of Justice, to perform this task.

This Chapter 7 Trustee is compensated, in fact, with a percentage of the proceeds retrieved in this manner. The possibility of the liquidation of assets or property must always, therefore, be a chief concern of any Michigan resident seeking relief from debt through Chapter 7 bankruptcy.

The good news, however, is that most Metro Detroit residents filing for Chapter 7 bankruptcy do not lose any property at all.

This is owing to the fact that Congress, when it drafted and enacted the US Bankruptcy Code, wished to protect debtors’ ability to make a “fresh start” in life. This is hardly possible when you are left with nothing but empty shoeboxes after a Chapter 7 bankruptcy process concludes.

Thus, Congress included in the Bankruptcy Code a number of provisions known as “exemptions.” These exemptions allow you to “exempt” certain types of property up to certain dollar value amounts from the “Bankruptcy Estate” that is created upon filing of the Chapter 7 case.

The Chapter 7 Trustee is, indeed, the Trustee of this Bankruptcy Estate. He or she has the authority to liquidate only property that is in the Estate when it is filed. That is, either property in the Estate or property that can be clawed back into the Estate through fraudulent transfer or other so-called “avoidance” actions.

More on avoidance actions and retirement accounts in Chapter 7 bankruptcy will follow, below.

 

Exempting Retirement Accounts in Chapter 7 Bankruptcy

 

The Bankruptcy Code and Michigan State law provide for a number of different exemptions for different types of property.

This Article will discuss only those that pertain to the exemption of retirement accounts. The first thing, however, to keep in mind is that there are retirement accounts—and, then, there are retirement accounts.

 

Tax-Qualified Retirement Accounts

 

Generally speaking, as noted in the introductory paragraph, above, a tax-qualified retirement account such as a 401(k), 403(b), of Simple IRA are easy to exempt and protect in Chapter 7 bankruptcy.

A “tax-qualified” account is one that meets the qualifications for tax exempts status under various provision of the IRS Code.

Such retirement accounts can be exempted with no value-cap under Section 522(d)(12) of the US Bankruptcy Code. What does “no value-cap” mean? Most bankruptcy exemptions cap the value of property that can be exempted. For example, as of this writing, you can exempt $1,875 in the value of jewelry under the application Federal bankruptcy exemption.

The retirement account exemption under 522(d)(12) has no such cap. You might have a million bucks in your 401(k), but 522(d)(12) will still allow you to exempt and protect it in Chapter 7 bankruptcy. Neither the Chapter 7 Trustee nor your creditors will be able to touch it.

With one exception, discussed below.

Note, however, that having an enormous retirement account may still present “good faith” issues for your Chapter 7 bankruptcy. Such a fat retirement account as that might trigger the filing of a motion to dismiss your Chapter 7 case by the US Trustee on the grounds that you’ve filed your bankruptcy in “bad faith.” (But this does not mean that the retirement account would be liquidated.)

 

Pension Plan Payments—to the Extent Reasonably Necessary

 

Pension plans and retirement accounts that are not tax-qualified can be exempted in a less comprehensive manner under Section 522(d)(10) of the Bankruptcy Code.

This exemption allows for a payment under a stock bonus, pension, profit-sharing, annuity, or other plan to be exempted to the extent reasonably necessary for the support of the debtor or the debtor’s dependents. The plan or contract underlying the payment must also be on account of age or service (i.e., retirement) and not for some other reason.

The “reasonably necessary” limitation is a big one. Big enough for a Chapter 7 Trustee to drive a Mack truck through when the possible reward is enticing enough for him or her. You may be entitled to monthly payments of $20,000 under some pension plan, for example, but any Michigan Bankruptcy Court Judge would likely agree with a pursuing Chapter 7 Trustee that that amount is much more than is reasonably needed for food, shelter, clothing, and medicine.

Never mind that you have live in a gold-plated mansion with a $19,000 per month mortgage installment payment.

 

Individual Retirement Annuities and Michigan Law

 

This “IRA” may be exempted with the Federal (Bankruptcy Code) exemptions only if it meets the “extent reasonably necessary” and the “on account of age or service” requirements described above.

Otherwise, any other sort of annuity or mutual fund cannot be exempted as a retirement account. It is, essentially, no different than a pile of cash—which cannot be exempted to any significant extent.

An exception: the Michigan Bankruptcy Exemptions allow for this in some circumstances.

Michigan statutes also provide a separate set of exemptions that can be used instead of the Federal exemptions. (Note that you cannot pick and choose from among them: you either use only Michigan exemptions, or you only use the Federal exemptions.)

Under Michigan law, you can exempt an Individual Retirement “Annuity.” However, this exemption is seriously limited.

Michigan’s retirement account exemption will only protect annuities as defined in Section 408 or 408(a) of the IRS Code. For any kind of “IRA,” the Michigan exemption will likewise protect only the deductible amount allowed under Section 408 of the IRS Code.

Thus, jamming the $50,000 you inherited from your Aunt Fanny into your IRA right before filing Chapter 7 with Michigan’s exemptions would be a bad idea.

Further, anything contributed within 120 days of the filing date of the bankruptcy is not exempt under Michigan’s statute, either.

 

Inherited Funds

 

Whether or not funds from someone else’s 401(k) or retirement account that you inherit and then rollover to your own retirement account can be exempted under the Federal exemptions has been a hot topic in bankruptcy case law over the past few years.

Long story short, bankruptcy judges have largely ruled that, if you didn’t earn the retirement funds yourself (“on account of service”), don’t count on protecting them in Chapter 7 bankruptcy.

Hire a good Michigan bankruptcy attorney to advise you if you have inherited your father’s 401(k) balance.

 

The Chapter 7 Trustee Retirement Account Clawback

 

Remember the avoidance action we promised we would discuss? Here it is.

An avoidance action is a legal proceeding initiated by a Chapter 7 bankruptcy to “avoid” (unwind or undo) a transfer that has been made by a debtor or other party in the time-period leading up to the Chapter 7 bankruptcy filing.

If the action is successful, the party who has received funds or property from the debtor (or the debtor’s business) will receive a court order requiring turnover of the property or cash to the Chapter 7 Trustee.

There are many different legal bases for a Trustee avoidance action. This Article, again, only discusses retirement account contribution avoidance actions.

 

Retirement Contribution Avoidance: 

 

The Federal Exemptions giveth—but they also taketh away. Under certain scenarios, a Chapter 7 Trustee may attempt to avoid or claw back retirement contributions made by the debtor within the 2 years prior to the filing of the bankruptcy case. However, these contributions must be proved to have been made with an intent to hinder, delay, or defraud creditors.

In other words, the Chapter 7 Trustee must prove that you made retirement contributions prior to filing for bankruptcy with the intent to defraud creditors.

This sort of argument will always revolve around the details of when you made contributions, in what amounts, according to which schedule, and what your financial state was the time that you made the retirement contributions.

That is to say, the evidence will usually be circumstantial. But the standard of proof in civil bankruptcy allows for the provision of such evidence. Bankruptcy is not, after all, a criminal proceeding in which guilt must be proved beyond a reasonable doubt.

The ability of a bankruptcy trustee to claw back or recover contributions made to a retirement plan shortly before filing for bankruptcy can depend on various factors, including the type of retirement plan, the timing of the contributions, and the bankruptcy laws applicable in your jurisdiction. Here are some key points to consider:

1. Type of Retirement Plan: The rules regarding whether contributions to retirement plans can be recovered by a bankruptcy trustee may vary depending on the type of retirement plan. Generally, employer-sponsored plans like 401(k)s and 403(b)s may have more protection from creditors than Individual Retirement Accounts (IRAs).
2. Timing of Contributions: The timing of contributions can be crucial. Contributions made to retirement plans well in advance of filing for bankruptcy are less likely to be considered fraudulent or recoverable by a bankruptcy trustee. However, contributions made shortly before filing for bankruptcy may raise red flags and be subject to scrutiny.
3. Bankruptcy Laws: The specific bankruptcy laws in your jurisdiction can impact whether contributions are recoverable. Different jurisdictions have different exemptions and rules governing what assets are protected from creditors in bankruptcy.
4. Intent and Good Faith: The bankruptcy trustee will examine whether the contributions were made in good faith or with the intent to defraud creditors. If contributions were made as part of a legitimate retirement savings strategy and not with the intent to hinder, delay, or defraud creditors, they may be less likely to be recovered.
5. State Exemptions: Some states have their own bankruptcy exemptions that can further protect retirement accounts from being used to pay off creditors. It’s essential to understand your state’s specific bankruptcy laws and exemptions.
6. Amount of Contributions: The amount of contributions made to the retirement plan can also be a factor. Large contributions made shortly before bankruptcy may be subject to more scrutiny than regular, ongoing contributions.
7. Consult an Attorney: Given the complexity of bankruptcy law and the fact that it can vary by jurisdiction, it’s crucial to consult with an experienced bankruptcy attorney if you have concerns about contributions to your retirement plan and how they may be treated in bankruptcy.

In summary, whether contributions to a retirement plan can be clawed back or recovered by a bankruptcy trustee depends on several factors, including the timing and amount of contributions, the type of retirement plan, and the bankruptcy laws in your jurisdiction. Consulting with a bankruptcy attorney who is familiar with your specific circumstances and local laws is advisable if you have concerns about this issue.

So you need relief from bankruptcy but have made retirement contributions … What do you do?

 

Defenses to Retirement Account Contribution Avoidance

 

A Chapter 7 Trustee must make his or her case to the court to take your retirement contributions. However, increasingly, the attorneys representing Chapter 7 Trustees in the Eastern District of Michigan are willing to throw such actions against the wall to see if they stick.

Thus, it is essential that you retain an experienced Michigan bankruptcy attorney to fend off naked Trustee aggression. (Remember: Chapter 7 Trustees get paid a percentage of what they liquidate—or what they manage to receive by way of settlement amounts that they scare debtors into offering.)

In fact, you have defenses to this sort of action. Some of these defenses may include:

• Lack of intent to defraud;
• Arguments regarding the timing of contributions;
• That the funds were actually exempt under Section 522(d) and thus untouchable under 522(o);
• And more.

 

How Can a Michigan Bankruptcy Attorney Protect Your Retirement Accounts?

 

Only an experienced Michigan bankruptcy attorney can adequately advise you as to whether your retirement account is safe in bankruptcy.

Attorney Walter Metzen is a Board Certified Bankruptcy Expert who has successfully represented Chapter 7 and Chapter 13 clients in Metro Detroit for over 30 years.

If you have contributed recently to your retirement accounts and are considering Chapter 7 bankruptcy, contact us now to schedule your free initial consultation.