Types of Bankruptcy

• There are several types of personal bankruptcy proceedings, but the ones most often used are Chapter 7 and Chapter 13. Chapter 7 is also known as a liquidation bankruptcy. Any non-exempt assets owned by the debtor are placed in a bankruptcy estate and liquidated by a trustee, and the proceeds are to dispersed to creditors. At that point, the person's debts are discharged, and the slate is wiped clean. A Chapter 13 proceeding allows debtors with assets to pay creditors over time based on a repayment plan. These debtors often have jobs, homes and automobiles and can still generate income to pay the debt. They are allowed to retain the assets to earn income. Discharge does not occur until the debts are paid off.
  
  

Exempt Assets

• Certain assets are exempt from inclusion in a bankruptcy estate. A 401k retirement plan, as well as other registered accounts, such as IRAs, are exempt because they cannot be liquidated or sold without tax consequences. This allows the debtor to retain the potential for a comfortable retirement after debts are discharged through bankruptcy. The exception to this rule is that any funds withdrawn from a 401k or other registered account become part of the bankruptcy estate. This affects debtors who try to avoid bankruptcy by taking money out of their retirement funds but who ultimately end up filing anyway.
  
  

Contributing to a 401k Plan Before Discharge

• During a Chapter 13 filing, you may consider continuing to contribute to your 401k plan at work before your discharge, especially if the employer matches your contributions. Each state's bankruptcy laws determine whether this is allowed. Prior to overall changes in bankruptcy law in 2005, these contributions were forbidden. As of 2011, some states allow them, as they recognize that continuing to make 401k contributions helps the debtor in the long run and increases the probability of financial stability. Check with a qualified bankruptcy lawyer in your state before making contributions.
  
  

Should You Cash Out Your 401k to Avoid Bankruptcy?

• If you have accumulated a large amount of money in your 401k plan and are facing the possibility of bankruptcy, you may consider cashing part or all of it out to pay your creditors to avoid filing bankruptcy. The appropriate decision depends on your circumstances, and you should consider consulting both a bankruptcy attorney and an experienced CPA. If you have other assets but no ongoing income, using your 401k funds to avoid bankruptcy may protect your other non-exempt assets from liquidation. However, any funds withdrawn become part of the bankruptcy estate if you end up filing bankruptcy later. Because your 401k plan will survive a bankruptcy filing, you may wish to consider filing and protecting your retirement plan.