How Chapter 7 bankruptcy can impact a 401(k) account

When a Connecticut resident is considering bankruptcy options, one of the most important considerations is how that choice could affect retirement savings. Many people spend the bulk of their adult lives setting aside money to fund retirement. They are concerned that seeking bankruptcy protection could jeopardize their savings, leaving them unable to retire as planned. The following information is offered in the hopes of clearing up the impact that Chapter 7 bankruptcy can have a 401(k) account.

During Chapter 7 bankruptcy, some of an individual’s assets may be liquidated under the direction of the trustee. The resulting funds are then used to repay creditors. However, there are regulations in place that control which assets are subject to liquidation and which are afforded protection during the bankruptcy process.

In most cases, a 401(k) is protected from liquidation or loss through the federal Employee Retirement Income Security Act. That said, an exception occurs for individuals who owe money to the IRS. The IRS has the ability to levy funds from a 401(k) to apply toward an overdue balance. In addition, the IRS can even levy future disbursals if an individual files for bankruptcy well in advance of retirement. That can lead to significant interest and fees, compounding the initial debt.

For Connecticut residents who are preparing to file for Chapter 7 bankruptcy and who also owe a debt to the IRS, it is important to make a plan for addressing tax debt. One option is to cash out a portion of the 401(k) to satisfy tax obligations, avoiding fees and interest. The best course of action depends on the unique financial circumstances of each individual, and is a matter to be discussed with one’s bankruptcy attorney.

Source: fool.com, “Can Creditors Seize My Investments During Bankruptcy?“, Sarah Szczypinski, July 19, 2017