401k and Bankruptcy: Is it in Jeopardy?

Posted by Wesley Scott on December 23, 2014 at 8:30 AM
Wesley Scott

401k_and_bankruptcyMost people spend their lives building up their assets. From homes and vehicles to retirement savings, the American dream is to be able to provide for these things. When an unexpected life event happens that causes a major blow to your finances, bankruptcy can be a viable solution to solve your financial troubles. However, for those contemplating filing bankruptcy, losing assets is a major concern. 

Because of bankruptcy myths that circulate by word-of-mouth and online, people who are struggling with debt and desperately need assistance hesitate to discuss bankruptcy options for fear of losing their assets.  In reality, most people who file for bankruptcy relief in Minnesota keep all of their assets while discharge most, if not all, of their debts.  Below we will address an issue that many people who meet with us for the first time want to address: 401k and bankruptcy.

What is a 401k?

A 401k is the most common type of employer-sponsored retirement savings plan. This type of retirement savings plan allows the employee to invest a percentage of his or her payroll before taxes are calculated.  In other words, if you choose to invest 6% of your payroll in a 401k plan, 6% of your gross payroll amount will be deducted before your taxes are calculated. Having a 401k is a very beneficial way to save because you are not taxed on the amount of money contributed to your 401k account and some employers match contributions up to a percentage.

Your employer acts as the plan sponsor who forwards the deduction from your paycheck for your 401k contribution to the company it has hired to administer the retirement plan and manage the investment of your retirement savings.   The plan administer invests the savings according to how you have chosen to invest your money.  Most plans allow participants to choose from several investment options including mutual funds, stocks, and bonds.  However, if you withdraw funds from your 401k account prior to retirement, you may be required to pay taxes and early withdrawal penalties on the amount withdrawn. 

401k and Bankruptcy

Depending on how long you have worked and contributed to your 401k account, you could have several thousand dollars or hundreds of thousands of dollars in your 401k account.  Therefore, it is only natural to worry about how your 401k and bankruptcy will affect each other.  Your 401k is an important part of your retirement planning and it is important to keep this account in tact in order to provide for your future.  If you are struggling to pay your debts, you may be tempted to withdraw funds from your 401k account to pay bills, especially if you are facing a foreclosure or a repossession.  In most cases, this would be a huge mistake.

The Supreme Court has ruled that 401k accounts are not property of a bankruptcy estate.  This means that a bankruptcy trustee cannot use the money in your 401k account to pay your creditors because these funds are protected in a bankruptcy case.  Therefore, rather than using your retirement funds to pay credit card bills, medical bills, personal loans and cash advances, you can file bankruptcy to discharge those debts while protecting your retirement funds for your future.  

Furthermore, if you are facing a foreclosure, you may be eligible to file a Chapter 13 bankruptcy case to save your home. Through your bankruptcy plan, you can catch up on the past due mortgage payments and keep your home without using the funds in your 401k account.  This protects both your home and your retirement funds while also erasing your unsecured debts.  At the end of your Chapter 13 plan, your credit cards, medical bills and other dischargeable unsecured debts will be erased, your mortgage will be current, and your retirement funds will have grown even larger during your bankruptcy.


Before you withdraw funds from your 401k account to pay for debts, we strongly suggest you consult with an experienced bankruptcy attorney to explore your debt relief options. They can help you find an affordable solution to your financial problems without touching your retirement funds.  For more information about what to expect during your bankruptcy consultation, download a copy of our free Bankruptcy Consultation eBook.

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Topics: Bankruptcy