Is 401(k) safe in bankruptcy?

If you are filing for bankruptcy, you will likely be relieved to hear that, yes, your 401(k) is generally safe in bankruptcy. They are considered exempt under the Employee Retirement Income Security Act (ERISA). So are most of your other retirement accounts — provided you do not withdraw those funds.

Creditors won’t have access to your 401(k) when you liquefy assets in Chapter 7 bankruptcy, and it won’t be considered an asset when your payment plan is determined under Chapter 13.

Because the exact bankruptcy exemptions and exclusions are determined by your state, you’ll need to work with a bankruptcy attorney to verify how your 401(k) will be treated. Even though your 401(k) is typically exempt, there are some circumstances where your retirement funds may still be at risk during bankruptcy.

Protected and unprotected assets in bankruptcy

Defined contribution plans are considered a protected asset under the Employee Retirement Income Security Act (ERISA) — and are thus safe from creditors during bankruptcy. According to the U.S. Department of Labor, these types of retirement savings accounts are considered defined contribution plans:

• Traditional 401(k)s
• Safe harbor 401(k)s
• SIMPLE 401(k)s
• Automatic enrollment 401(k)s
• Simplified Employee Pension Plans (SEP)
• SIMPLE IRA plans
• Employee stock ownership plans (ESOP)
• Profit-sharing plans

While traditional IRAs and Roth IRAs are not protected assets under ERISA, they are protected under the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). This extends federal protections to both IRAs up to $1 million — through the exact dollar amount is adjusted for inflation every three years. As of Sept. 30, 2024, the aggregate bankruptcy exemption is capped at $1,512,350 for IRAs.

ERISA accounts in bankruptcy

ERISA requires your employers to hold your retirement funds in a trust. Because that trust isn’t accessible to you until you reach a certain age, ERISA keeps your retirement safe from creditors.

Your 401(k) and certain other retirement accounts aren’t liquid assets. Because they can’t be sold like a savings account or extra car, they can’t be used to pay back your debts during bankruptcy.

While your 401(k) is safe, you likely won’t be able to make contributions to it during your Chapter 13 bankruptcy payment plan. In most cases, all your disposable income must go toward paying your creditors. Some states do allow you to make retirement contributions, but you will need to speak with your bankruptcy attorney to be sure.

If you are already receiving retirement income from a 401(k), it will be considered during bankruptcy. Under the BAPCPA, your disposable income — even from retirement savings — must be under a certain threshold to qualify for Chapter 7. Your creditors can’t take control of your account, but the court will use it to determine your payment plan under Chapter 13 if you aren’t eligible for Chapter 7.

When your 401(k) could be taken

There are three situations where your 401(k) may not be safe during bankruptcy.

Unpaid income tax

The IRS may seize your 401(k) or other retirement accounts if you have unpaid federal income tax and associated fees. However, your 401(k) will likely still be safe during bankruptcy if you owe state income or property taxes.

Qualified domestic relations order

A former spouse, current spouse or a dependent may submit a qualified domestic relations order to be added as an alternate payee. Your spouse or dependent will be entitled to a percentage of your retirement plan. If you have unpaid child support or alimony, you may also be required by the court to withdraw funds from your retirement accounts — even if it means paying additional penalties or fees.

Criminal fines and penalties

Your 401(k) or other retirement savings could be used to pay for federal criminal fines and penalties. This is similar to any unpaid income tax. While the federal government has the ability to seize money from your 401(k), state and local authorities generally don’t.

401(k) funds as a way to pay off debt

In most circumstances, you should avoid using your 401(k) to pay off debt or stay afloat. Because of the penalties, fees and taxes — and potential interest if you take out a 401(k) loan — you stand to lose a significant chunk of money from your retirement savings.

Always talk to a bankruptcy attorney before digging into your 401(k) or paying off outstanding debt. Because federal and state laws vary so widely, you need to plan your bankruptcy to avoid losing assets you’re otherwise entitled to keep.

Because your 401(k) is a protected asset under most circumstances, don’t risk future financial security to pay off debt.

One alternative option is to use a debt consolidation loan, a type of personal loan, to pay off higher-interest debt. Debt consolidation loans work by paying off multiple existing debts — such as variable-interest credit card debt, payday loans or other personal loans — with a single fixed-interest loan. If you can qualify for a low personal loan rate, you may save a ton of money and boot debt to the curb faster.

Debt consolidation loans may even be an option if you have bad credit. Some lenders provide loans to borrowers with average or poor credit scores. However, if you qualify for one with bad credit, a lender will likely charge you a high interest rate and fees.

Filing bankruptcy after retirement

The ideal situation is to have enough stashed away to live a comfortable retirement. However, some seniors may be facing high medical bills, credit card debt or insufficient retirement funds, so filing for bankruptcy might offer some debt relief.

Even if you are retired, if you still have funds put away in retirement accounts, those are generally protected under ERISA. BAPCPA still protects funds put away in IRAs.

Work with a bankruptcy lawyer to learn which assets can be exempted from a bankruptcy case. Every state has different laws that affect how your assets are handled in bankruptcy, such as home equity. You might also work with a bankruptcy lawyer to find ways to keep your home (if you own it). There are also exempted income sources that may affect seniors, like Social Security income.

The bottom line

Your 401(k) — and most other retirement savings accounts — are protected during bankruptcy. Work with a bankruptcy attorney to determine how to handle your savings. But in general, your retirement should be safe from creditors whether you file Chapter 7 or Chapter 13 bankruptcy.