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New bankruptcy legislation could
endanger your retirement savings

Bankruptcy rules threaten your life savings?June 23, 2000 -- Your retirement savings could be diverted to pay off credit-card balances in bankruptcy under a proposed revision of federal bankruptcy law.

It is even conceivable that an exorbitant doctor's bill that pushes you into bankruptcy could be paid off with your 401(k) or pension -- against your will.

That's because you may have unknowingly agreed to these arrangements at a time when you were financially healthy and blissfully unconcerned by the thought of bankruptcy.

Members of the U.S. House and Senate are working out differences in bankruptcy bills they each passed this session. Their goals are to cut what are perceived as abusive bankruptcy filings and to get more money into the hands of creditors, especially credit-card issuers.

As mentioned in a previous Bankrate.com article, the bills mandate means-testing to determine whether bankruptcy filers will have to partially repay unsecured debts, and require debtors to attend credit-counseling classes before they can file for bankruptcy.

Congressional leaders have cooked up a plan whereby the differences in the House and Senate versions of the bankruptcy bills will be resolved informally and in secret instead of in a formal, public conference committee. Then they intend to tuck the voluminous bankruptcy reform language into another bill, probably an innocuous one that won't generate much opposition or attention.

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Beware the small print and other traps
The Senate version of bankruptcy reform, which that chamber passed on Feb. 2, contains a section where individuals can sign away their claims to their own retirement savings before or during bankruptcy. The White House, a senator, bankruptcy experts and the retirement-planning industry have registered their opposition.

Normally, creditors can't touch assets of a 401(k) plan, Keogh plan or pension fund in bankruptcy proceedings. Current law prohibits creditors from raiding retirement plans because lawmakers intended bankruptcy to give debtors a fresh start, free from a lifetime of suffering over unpayable debts.

But under the Senate version of bankruptcy reform, unsecured creditors such as credit-card lenders and utility companies could tap the assets of your retirement account if you previously gave them permission to do so.

Why in the world would you give your permission? By not reading -- or not understanding -- the fine print in the paperwork you sign.

"I fear that many individuals will sign away their pensions unknowingly," Sen. James Jeffords, R-Vt., said at a congressional hearing in April. "Even for knowledgeable consumers, the cost of applying for a credit card should not be one's retirement security."

During the hearing that followed, experts criticized the proposal as bad policy that could not only permanently impoverish people who declared bankruptcy following illness, job loss or divorce, but also deter employers from offering retirement plans at all.

A problem of protection
Bruce Markell, a law professor at the University of Nevada-Las Vegas, told the panel that the proposal doesn't "provide any procedural protections to ensure that any waiver is voluntary and intentional." In fact, he added that there is no requirement that the waiver be written.

The pension-grabbing language might be in the boilerplate of a credit-card application or in an amendment printed in small type and stuffed into a monthly bill. In the latter case, you might signal your acceptance of the new terms just by continuing to use a credit card.

"It might very well find its way into the terms of service for those who provide services on unsecured credit such as doctors and even utility companies," Markell said.

Imagine the uproar the first time a doctor grabs a patient's pension because the medical insurance capped out and the patient had to declare bankruptcy.

President Clinton has sent a letter to Congress saying he was "concerned" that the bill could "eliminate protections for reasonable retirement pensions that reflect years of contributions by workers and their employers," but he didn't threaten a veto. Indeed, he used the stronger word "disturbed" to describe his reaction to another potential problem in the bill -- that Congress might not plug a loophole that allows violent or vandalistic antiabortion demonstrators to declare bankruptcy to avoid paying damages to abortion clinics.

'Millionaire's cap'
Sens. Chuck Grassley, R-Iowa, and Jeff Sessions, R-Ala., have stepped into the retirement fray by proposing what they call a "millionaire's cap." That term refers not to Mark McGwire's hat but to blanket protection for all retirement assets up to $1 million.

The cap would be $250,000 for those under age 21 and steadily increase to reach $1 million for those age 65 and older.

The Grassley-Sessions proposal would seem to cover individual retirement accounts, whether regular or Roth. Under current law, IRAs usually, but not always, are protected in bankruptcy, depending on the wording of the IRA agreement and what state the debtor lives in.

Homes in the range
Another hot issue in the debate over bankruptcy reform deals with the "homestead exemption." In five states -- Florida, Texas, Kansas, Iowa and South Dakota -- a bankrupt debtor can keep his or her primary residence, no matter how valuable it is. Because of this, ritzy enclaves like Boca Raton, Fla., are beacons for millionaire scam artists who abuse the bankruptcy system: an owner of a $3 million seaside mansion can declare bankruptcy and keep his "house."

The Senate version of bankruptcy reform would put a national cap of $100,000 on the homestead exemption nationwide. Under this plan, creditors could force the sale of a bankrupt debtor's house. The owner could keep the equity up to $100,000 and the creditors could get the rest.

The House version would establish a $250,000 cap nationwide, but would allow states to set a larger cap after the federal law goes into effect. This proposal has its critics, but it probably is more to the liking of the Florida and Texas congressional delegations, who represent one in eight Americans and wield a lot of political power.

Texas Gov. George W. Bush, now virtually unopposed in the Republican presidential nominee race, supports his state's unlimited homestead exemption.

-- Posted: June 23, 2000

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