While there is no typical age at which to file for bankruptcy, people frequently run into cash flow problems later in life, after they have established retirement savings plans. Unfortunately, many people liquidate their 401(k) or other retirement savings fund in an effort to pay off their creditors. Not only are there frequently insufficient funds to cover the amount of debt but the debtors also incur huge tax penalties and burdens from liquidating a large retirement fund. Another problem with this approach to getting out of debt is that it leaves the person completely unprepared for retirement.
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The good news for those with retirement accounts is that most forms of retirement savings are unaffected by filing for bankruptcy. They are not affected by bankruptcy because they are either not property of the estate or may be claimed as exempt from the claims of creditors.
In 2005, there was a huge law passed that made significant changes to the bankruptcy code. This law expanded the protection offered to retirement accounts. The changes to the code increase the protection afforded IRAs, Roth IRAs, and then majority of company accounts. These accounts are protected only in bankruptcy cases not in other judgments. The Employee Retirement Income Security Act (ERISA), passed in 1974, gives retirement funds protection in other types of cases.
The Supreme Court, in Rousey v. Jacoway in 2005, held that an employee's interest in pension plans that are qualified and protected by ERISA and the Federal pension laws are not part of an individual's estate. The debtor is not required to exempt a plan for it not to be counted by the trustee in charge of his bankruptcy case.
Retirement plans that are property of the estate can be used to pay off creditors. These include some Keogh plans and IRAs. Fortunately, these can be exempt as long as their value is one million dollars or less. While this may sound low, the majority of IRAs do not have a value of more than one million dollars. The accounts that do have a value above the cap are typically the product of company roll-overs. Funds that are from a company roll over are exempt from the cap.
As a general rule, funds in plans which are exempt from income taxes are also protected in bankruptcy cases. These instances fall under the tax code of the United States Code in sections 401, 408 A, 414, 457, and 501 (a). This includes 401(k)s, 403(b)s, IRAs, Roth IRAs, government retirement plans, and tax-exempt organization plans.
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