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Can your 401(k) be tapped to cover bankruptcy?

For people in Iowa preparing to go through bankruptcy, it can be terrifying to imagine which of your financial assets may be used to pay off debts. Some worry that creditors could even go after their retirement plans, such as a 401(k) plan. The truth, however, can make you breathe a little easier. The fact is that your 401(k) is actually well protected.

According to the Motley Fool website, the Federal Employee Retirement Income Security Act (ERISA) prohibits your 401(k) plan from being accessed by creditors to pay off debts during bankruptcy. One of the purposes of the ERISA is to protect retirement assets in times of financial trouble. Such protection also applies to your investments if they are sponsored by your employer. Additionally, ERISA also protects investments that qualify under the Internal Revenue Code's section 401(a).

However, that does not mean your 401(k) is completely out of the bankruptcy woods. The Internal Revenue Service (IRS) does retain some ability to use your 401(k) to settle back taxes. While the IRS still cannot tap into your 401(k) before you are ready to retire and tap into it, the IRS can levy a disbursal against it when it comes time for you to draw on it. Also, by levying a disbursal now, the disbursal will accumulate interest and penalties until the time the 401(k) is ready to be tapped.

Generally, however, the IRS will put off this kind of action unless they view it as a last option. You also have the choice of settling with the IRS early by asking for a hardship withdrawal from the 401(k) and using that to settle the levy. While an early withdrawal can be taxed by the IRS and subjected to an early penalty, the IRS is likely to set aside penalties if they see you are trying to resolve the debt.

This article is intended to educate the reader on bankruptcy and 401(k) plans and is not to be taken as legal advice.

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