A Retirement Plan Rescue Story, Bankruptcy-Style

January 22, 2008 7:37 am Published by


In the process of reading different news and feature items on the Internet, I’m always looking for stories about bankruptcy cases.  As a bankruptcy attorney in Indiana, I particularly like tales of bankruptcy court cases in other states.  This one story from Virginia caught my eye, since it relates to a topic I’ve been writing about recently in this blog.

You might recall me discussing retirement plan money, including money in 401K plans, SEPs, and SIMPLE plans, and even in IRAs.  The important point I made is that, not only does money grow tax-free inside retirement plans, but that retirement plan money is exempt from creditors under bankruptcy law.  (I explained that the reasoning is that retirement accounts are meant to help provide financial security in people’s later years.)

Well, in this true story about a bankruptcy case in Virginia, the client was being hounded by creditors and decided to file a Chapter 7 bankruptcy.  Basically this man had three things going for him – he had $15,000 equity in his home, he had military pension money coming in each month, and he had a 401K plan through his employer.  The fellow was resigned to losing his home.  (He didn’t have $15,000 to pay towards his debts and was sure the home would be sold by the bankruptcy trustee and the proceeds used to pay the creditors.)

Well, you recall that 401K money is protected from creditors as long as it is inside the retirement plan account.  So the big challenge, once this man had filed a Chapter 7 bankruptcy, was getting hold of $15,000 to pay towards his debts, because otherwise his house would have been sold to free up that $15,000 in equity.  Acting on good advice from his bankruptcy attorney, what this guy did was request a “hardship withdrawal” from his 401K plan.  (Many, but not all, 401K plans have a hardship withdrawal feature.)  That 401K withdrawal money went to pay the creditors (some had to be set aside to pay the tax that was now due on the withdrawal itself).  Now, having $15,000 to use towards paying his mortgage debt, the man was allowed by the bankruptcy court to keep his house.  The bulk of the 401K money stayed where it was, as did his military pension.

As a consumer bankruptcy specialist, I see two “morals” in this true story from Virginia.  First of all, bankruptcy law is very careful to preserve retirement plan savings for people’s later years.  If bankruptcy is to mean a fresh start on life, a person’s retirement years must be considered in the mix.  Second, as is almost always the case, for this man obtaining – and following – professional advice when filing bankruptcy really paid off.


 

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This post was written by Mark Zuckerberg

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