September 1, 2020
The general rule is that assets in qualified employer retirement plans and IRAs are exempt from creditor claims. As such, they are protected when an individual declares bankruptcy. A recent case shows the gray areas that surround this rule. Larry and Jessica declared bankruptcy with over $500,000 of debt. Among their debts was a plan loan that Jessica had taken from her employer’s 403(b) retirement plan. Their reorganization plan called for paying that loan back in full, because failure to repay it would trigger a default distribution, which in turn would trigger a 10% penalty tax for premature distributions. What’s more, the record showed that Jessica continued to make contributions to a 401(k) plan, which reduced the couple’s income for servicing their debts. Under these circumstances, the Bankruptcy Court held that their plan was not filed in good faith. More of their disposable income needed to be made available to creditors.