Even Smart People Keep Getting This Wrong – Retirement Accounts in Bankruptcy
One of the more frustrating parts of working as a consumer bankruptcy attorney is overcoming misinformation and myths about bankruptcy. The podcast The Weeds is often full of good information, but it recently repeated a myth multiple times that is very harmful to consumers: that filing bankruptcy means losing your savings.
That is simply not true.
We cannot tell you how many consultations we have conducted where the client drained their 401(k), IRA and cash savings accounts over years of futile attempts to repay creditors. They come to us broke, some having exhausted over a million dollars that could have been preserved in bankruptcy, while getting rid of debt.
That dumbfounded and shameful expression the client makes when they realize they could have kept their savings is an awful experience. We want to change that misunderstanding.
For those unfamiliar, the podcast follows a format of discuss one or two issues, such as healthcare or a political race, then discussing a white paper at the end of the show. The episode at issue discussed a white paper talking about Medicaid expansions and its effect on an individual’s ability to save. Here’s what was said.
Sarah Kliff at 53:04: “One of the ideas…raised [in the research paper] is that low income families already kind of had a high deductible insurance plan. It was called bankruptcy. That you could eventually file for bankruptcy, it would wipe out your savings, but, you know, you wouldn’t have that medical bill anymore. And that kind of raised the question of why bother saving if you’re just going to lose all that money to a medical bill at some point.”
Later at 54:27 Sara Kliff discusses how the study showed the Medicaid expansion allowed individuals who now received Medicaid benefits to save money because “you’re saving this money; you’re not going to lose it through a bankruptcy filing.”
Ezra Klein at 56:04 says “You’re seeing a situation where the people really under financial hardship are basically refusing to save because they need the option of going bankrupt.”
Whether Chapter 7, 11 or 13, individuals get to keep their 401(k), 403(b), IRA and other common retirement accounts. Even though a Chapter 7 is called a “liquidation,” the person gets to exempt and protect certain assets from liquidation. If we had to throw out an estimate for our firm, we would guess 95% of Chapter 7 cases result in no liquidation of any assets; that is the exception and not the rule. And if there is a liquidation, it’s not retirement accounts because the exemptions that remove those from liquidation are quite strong.
Maybe we can’t exempt the fancy car or jewelry collection entirely, and some of that is liquidated. But retirement is generally off the table. There are some minor exceptions such as fraudulent use of retirement accounts, or exceeding the $1,283,025 cap on IRAs; that’s a luxury and not a problem for your average person if you exceed the IRA cap. There is no cap on 401(k), 403(b) and similar accounts, by the way.
Regular cash savings are protected up to a certain amount, and varies by state. In California, we currently enjoy a “wildcard” exemption that is over $28,000. Yep, we have some clients that file with a million dollars in retirement, and $20,000 in cash, and they keep every penny.
We can’t write a response to every misstatement about bankruptcy because that in itself is a full-time job. But there some myths that can visit great harm upon your average consumer. That misinformation can make it into the ethos to the point of a group of smart people talking about a wonky white paper assume that it is true, and casually repeat it a few times to tens of thousands of listeners (hundreds of thousands?), and it just becomes accepted as true.
Has a client ever walked into our office and said, “I drained my savings because Sarah Kliff and Erza Klein said I would lose it if I didn’t use it?” No. But we do need the smart people that disburse information to large swaths of the public discussing a wonky paper to correct the misstatements, and, at the very least, state accurate information going forward.
Photo courtesy of dragoku.