When you file for bankruptcy for consumer debt, everything that you own generally becomes part of your bankruptcy estate. The bankruptcy trustee in charge of the estate could sell these assets to raise funds to pay debts. However, most debtors will find exemptions under the Bankruptcy Code that will protect all, or at least most, of the property in their estate. Property that could not be exempted may remain in the estate because the trustee will look at the cost of selling it versus the amount that a sale would bring and decide to abandon or sell the property back to the debtor. On the other hand, the status of pensions, retirement funds, and similar accounts still is somewhat ambiguous in bankruptcy law.
Looking at the Bankruptcy Code, Section 541(c)(2) states that restrictions on transferring a debtor’s beneficial interest in a trust which are enforceable under applicable nonbankruptcy law will remain enforceable in a bankruptcy case. If the law shields a beneficiary’s interest in a trust from creditors, then the same protection applies during a bankruptcy.
In 1992, the U.S. Supreme Court decided the language in this section applied to certain types of pensions. ERISA-qualified pension plans were found to be excluded from the bankruptcy estate because this federal law had an “anti-alienation” provision that protected pensions that are covered by ERISA.
Then, in 2005, the Bankruptcy Code was amended. Section 522 was revised to allow the debtor an exemption, usually without limitation, in most types of retirement funds. With this change, whether or not a pension is part of the bankruptcy estate ceased to be an important issue when attempting to protect such plans after a bankruptcy filing. Congress also added provisions stating that any amount withheld or received by an employee in retirement funds or employee benefit plans are not property of the bankruptcy estate.
This does not protect everything, however. If you file for bankruptcy while you are in the process of rolling over your pension funds into another plan, you leave yourself open to the claim that these funds were not in an ERISA-qualified plan when the bankruptcy was filed. Therefore, as the argument goes, your retirement funds should not be excluded from your bankruptcy estate. This also shows the importance of timing when you decide to file for bankruptcy. Under this scenario, to avoid a possible problem, you could wait to file your bankruptcy case or undertake the rollover. By doing so, the bankruptcy case will be filed while retirement funds are in a qualified plan.
Non-ERISA plans face other issues. For example, the Supreme Court’s 1992 decision pointed to retirement funds that do not qualify under ERISA, determining that they are not entitled to its protection as a result.
Individual retirement accounts (IRAs) would be an example here. However, IRAs now qualify as exempt under subsections 522(b)(3)(C) and (d)(12) (with a $1,245,475 waivable cap for funds that were never rolled over from another plan) and may also be protected from alienation under state law. In addition, if a debtor cannot reach funds in a plan, the bankruptcy estate has the same limitation – it cannot have greater rights than the debtor. Therefore, with the already existing protections plus the expanded ones for retirement savings, a debtor will rarely lose retirement funds in a bankruptcy case.
Other types of plans may be considered spendthrift trusts, with the beneficiary having no right to access the funds whenever the individual so desires. Under the laws of most states, due to this limitation, the beneficiary’s interest in such a trust is protected from the person’s creditors. These trusts are excluded from the debtor’s estate under Section 541(c)(2). However, it should be noted that not all spendthrift trusts are protected under state laws – an example is the “self-settled” spendthrift trust created by its own beneficiary, which most states do not protect from this person’s creditors.
Finally, when possible, the debtor also must remember to list retirement funds, pensions, and similar trust interests in Schedule B of the bankruptcy schedules, even if they do not come into the estate. Any argument that the interest is outside the estate should be noted on Schedule B with a reference to subsections 541(c)(2) or 541(b)(7) of the Bankruptcy Code. In addition, nothing prevents a debtor from claiming on Schedule B that property is outside the estate but listing an applicable exemption on Schedule C in the alternative as a backup.