Yes, your 401(k) is safe in bankruptcy. You can file bankruptcy, not pay one penny on your credit card debt and keep your 401(k). I have filed bankruptcy petitions for clients with less in credit card debt than money in a 401(k) or retirement account. The debt was wiped out completely and the client kept every penny of the 401(k).
I am not writing this column to give my opinion on whether this is fair or reasonable. I know some people would be upset to learn that someone can keep all the good and get rid of all the bad. This is one of the only times we do get to behave like corporations. Many people feel this is a morally or ethically corrupt scenario in which we all pay for higher interest rates and credit card fees while this person wipes out all of his or her debt.
I am writing this column about the importance of timing.
A colleague of mine filed a bankruptcy petition for a client with a substantial balance in his 401(k) and a considerable amount of debt. The attorney told the client that the 401(k) money was protected and that the debt could be eliminated. But it is only protected as long as it remains in the 401(k) account.
Taking the money out of the 401(k) or any retirement account prior to filing converts the funds from a protected to an unprotected asset. Basically, the funds went from a retirement nest egg to money being used for daily expenses. Funds in checking accounts, savings accounts and other nonretirement investment accounts don't receive the same protections as retirement funds.
Since the client was told the money was safe, he took out the money and put it into his bank account. Fortunately, the attorney discovered the transaction before filing the case; otherwise, the client could have lost some or all of that retirement money.
This doesn't happen in a vast majority of cases, but I'm always careful to make sure the client understands this distinction during the initial consultation and preparation of the petition, especially if he or she has just lost a job and needs the retirement money to pay monthly expenses. The above example is always avoidable if there is ample communication between client and attorney.