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The Maximum IRA Exemption

Most pensions and other retirement funds are “exempt”—completely protected when you file bankruptcy. But there’s an exemption cap for IRAs.

Property Exemptions

When you file a Chapter 7 “straight bankruptcy” case usually you are able to keep everything you own because of property “exemptions.” These are usually categories and amounts of assets that people are allowed to keep, and their creditors and the bankruptcy trustee are not allowed to take. For example, there are homestead exemptions for your home, vehicle exemptions for your vehicle(s), and usually many other categories.

The intent behind exemptions is that you can’t really get a fresh financial start if you have to give everything to your creditors. So the exemptions protect a basic set of assets. Depending on where you live and what assets you own, you have a right to exemptions through your state’s laws and possibly also through federal laws.

As long as the exemption categories and amounts cover everything you own, you can keep everything in a Chapter 7 bankruptcy. To the extent you own something that isn’t covered, you may have to surrender it to your creditors.

Or you can often protect it through a Chapter 13 “adjustment of debts.” You protect what a Chapter 7 trustee would have been able to take from you by paying for the right to keep it through a payment plan, while all your creditors are prevented from taking any collection action against you or your assets.

Most Forms of Retirement Are Protected in Bankruptcy

Exemptions cover not just tangible assets but also certain rights and intangible assets you may have, such as your retirement funds.

Retirement funds held in virtually all forms are exempt—fully protected—when you file any kind of bankruptcy case. Almost all tax-exempt forms of retirement are covered, no matter how much in value.

Conventional pensions—both defined benefit and defined contribution plans—are exempt. Profit sharing and stock bonus plans are exempt. 401(k) plans and Employee Stock Ownership Plans (ESOPs) are exempt. Social security is usually exempt.

This is true no matter where you live. In a majority of the states residents are required to use that state’s set of exemptions instead of a federal set. But ever since a major amendment of the Bankruptcy Code in 2005, all tax-exempt (“ERISA-qualified”) retirement plans are protected when you file bankruptcy anywhere in the United States.

All of these retirement plans are exempt no matter how much their value. That is, almost all of them.

The (Relatively High) IRA Exemption Cap

However, there is a cap on the amount of funds that you can exempt in a traditional Individual Retirement Account (IRA). (See Section 522(n) of the Bankruptcy Code.) That cap is so high that it won’t affect most people reading this, but it’s something to be aware of.

The maximum amount of money that can be exempt in a traditional IRA was set at $1 million in the 2005 bankruptcy law amendment mentioned above, with future cost-of-living adjustments (Section 104).

The Cap Is Increasing April 1

This IRA exemption maximum has gone up every 3 years, up to $1,245,475 in 2013, and now on April 1, 2016 is increasing again to $1,283,025.

This cap does NOT apply to either “SEP IRAs” (Simplified Employee Pensions) or “simple IRAs” (Savings Incentive Match PLans for Employees).

Retirement Funds vs. Paid Retirement Benefits

Careful: while funds in your retirement accounts are exempt from creditors (except as just discussed), retirement benefits that are being currently paid to you as income are not necessarily exempt.

Under Chapter 7 bankruptcy, the bankruptcy trustee cannot take any retirement benefits that are necessary for your support, but under certain circumstances might be able to use amounts in excess of that to repay your creditors. Under Chapter 13 bankruptcy, all retirement income is calculated into your repayment plan and will help determine how much of your debts you must repay while you are in the plan.

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