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What happens to a retirement account in bankruptcy?

A common question asked by New Yorkers who are contemplating bankruptcy is what happens to retirement savings. Can the trustee use retirement assets to pay creditors? Can creditors garnish funds in a retirement account? The answer depends upon the type of account in which funds have been accumulated and upon the law of the state in which the debtor lives. Whether a person chooses Chapter 7 or Chapter 13 generally makes little difference in protecting assets in a retirement account.

In New York, most employer-sponsored plans are subject to the Employee Retirement Income Security Act ("ERISA") and are therefore completely exempt from the claims of creditors, except former spouses, seeking child support or alimony and the Internal Revenue Service. The exemption also applies to 401(k) plans. New York law makes 100 percent of the funds in a retirement account while the money remains in the account, but some states place a limit on the amount that is exempt.

The news is not as good for individual retirement accounts. IRAs are not covered by ERISA, and they are therefore not subject to the blanket exemption from creditor's claims that ERISA provides to employer sponsored plans. Still, federal law provides a $1,000,000 shield for funds contributed to the plan by the debtor.

Generally speaking, retirement savings lose any exemption once they are withdrawn from the plan. However, when a plan is rolled over into an employer-sponsored plan, the entire amount of the roll over acquires ERISA protection.

The great variety in retirement plans and IRAs means that a person considering bankruptcy may wish to seek advice from a capable bankruptcy lawyer. A knowledgeable attorney can provide advice on the size exemption available for each type of savings plan and techniques for minimizing the amount of plan assets that are vulnerable to creditors' claims.

Source: New York Times, "Protecting Retirement Accounts From Creditors," Deborah L. Jacobs, April 1, 2009

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