Keep your retirement assets and life insurance through bankruptcy

One of the biggest assets owned by Americans, other than their homes, is their retirement plan. Through the explosion of 401(k) accounts and mutual funds over the past 25 years, many have assembled a significant retirement nest egg through regular payroll deductions. Of course, there’s a catch — the money is inaccessible without paying a hefty tax and penalty, and in some instances can only be withdrawn (or borrowed against) by a showing of financial emergency.

But having a significant retirement account doesn’t help you when a job loss, medical problem, business failure, death, or other financial disaster strikes. In those situations, a bankruptcy discharge may be the only way to get relief — and in doing so, you can keep your qualified retirement assets.

A “qualified retirement” asset is one that enjoys tax benefits, typically a combination of:

  • tax deductibility of contributions;
  • tax-deferred growth; and/or
  • tax exemption of proceeds upon proper withdrawal

And of course, all qualified plans have a 10% penalty (plus accrued taxes, if any) upon early/improper withdrawal.

The vast majority of employer-sponsored retirement plans (defined benefit pensions, defined contribution pensions) and employee-contribution plans (401(k)s, 403(b)s, many thrift savings plans, etc.) are qualified retirement plans. Individual Retirement Accounts (IRAs) and Roth IRAs are also qualified retirement plans. If you get a tax break on a long-term retirement savings account, chances are it’s a qualified retirement plan and exempt from creditors in bankruptcy. You can keep it!

The same is true for cash value life insurance policies. Many of these are called “whole life,” “straight life,” “variable life,” or “universal life,” and what they have in common is an accumulation of cash surrender value over time. Cash value life insurance is also exempt from creditors. This is important, as cash value grows on a tax-deferred basis in a similar manner to qualified retirement plans. You don’t pay the taxes until you take it out. For this reason, life insurance is used by some financial planners as a way to supplement those who don’t have a qualified retirement plan or who have maxed out their contributions.

The important message through all of this: bankruptcy doesn’t have to wipe out your retirement or life savings. If you have a financial crisis and need relief, don’t let fear of losing these assets keep you from consulting with a qualified attorney about your bankruptcy options.