Bankruptcy’s Effect on Retirement Accounts: What You Can Keep Safe

Watching a lifetime of hard work and savings feel threatened by overwhelming debt is a deeply stressful experience. For many Alabamians, the single biggest source of fear when considering bankruptcy is the nest egg they so carefully built. You have spent decades contributing to a 401(k), an IRA, or a pension, all with the promise of a secure future. Now, faced with medical bills, credit card debt, or a sudden loss of income, the question becomes a deafening one: “Will the bankruptcy court take my retirement savings?”

The Short Answer: Are My Retirement Accounts Safe in an Alabama Bankruptcy?

For the vast majority of people, the answer is yes.

Thanks to federal legislation, specifically the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), most legitimate retirement accounts are shielded from creditors and the bankruptcy trustee.

These protections are in place for both Chapter 7 (liquidation) and Chapter 13 (repayment plan) bankruptcy filings. The law is designed to prevent a situation where solving today’s debt problem forces you into poverty in your senior years.

How Federal Law Creates a Strong Shield for Your Nest Egg

When you file for bankruptcy in any of Alabama’s districts (Northern, Middle, or Southern), all your assets technically become part of a “bankruptcy estate.” A court-appointed trustee manages this estate. The trustee’s job in a Chapter 7 case is to gather any non-exempt assets, sell them, and use the proceeds to pay your creditors.

The word “exempt” is the key. Exemption laws are lists of property that the trustee is not allowed to take. Both federal law and Alabama state law have their own sets of exemptions. For retirement accounts, the federal protections are exceptionally strong and, in most cases, supersede state-level exemptions.

The “ERISA” Shield: Why Your 401(k) and Pension Are Secure

The strongest protection available is for retirement plans that are “ERISA-qualified.” ERISA stands for the Employee Retirement Income Security Act, a federal law that governs most employer-sponsored retirement plans.

Here is the most important distinction: ERISA-qualified funds are not even considered property of the bankruptcy estate. They are legally excluded from it. This means they are not subject to any dollar-limit cap. Whether you have $50,000 or $5,000,000 in your 401(k), it is protected.

Common types of ERISA-qualified plans that receive this unlimited protection include:

• 401(k) plans
• 403(b) plans (common for teachers and non-profit employees)
• Defined-benefit plans (traditional pensions)
• Profit-sharing plans
• Money purchase plans
• Thrift savings plans (TSPs) for federal employees

If your savings are in one of these accounts, you can generally rest assured that they are fully protected from the bankruptcy process.

What is the Protection for IRAs (Traditional and Roth)?

This is where the rules change slightly. Individual Retirement Accounts (IRAs) and Roth IRAs are not governed by ERISA. Therefore, they are not automatically excluded from the bankruptcy estate.

Instead, IRAs are treated as exempt property. This means you must list them as an asset and then claim a specific exemption to protect them.

What is the Current IRA Exemption Limit in Bankruptcy?

While ERISA plans have unlimited protection, IRAs (including Traditional, Roth, SEP-IRAs, and SIMPLE IRAs) are protected up to a specific, combined dollar amount.

As of April 1, 2025, the federal exemption for IRAs is $1,711,975.

This cap is adjusted every three years for inflation. This is a very high limit, and for the overwhelming majority of people filing for bankruptcy, it means their IRAs are completely safe. If your combined IRA balances are below this $1.71 million threshold, the trustee cannot touch them.

Does It Matter That I Live in Alabama?

Alabama is what is known as a “chooser” state. This means when you file for bankruptcy here, you must choose between using the Alabama state exemptions or the federal exemptions. You cannot mix and match.

• Alabama’s state exemptions provide for a certain amount of protection for your home (homestead), car, and personal belongings.
• The federal exemptions offer a different set of protections, including a more generous “wildcard” exemption that can be applied to various types of property.

However, when it comes to retirement accounts, BAPCPA made the federal protections for IRAs (up to the $1,711,975 cap) and the unlimited protection for ERISA plans available to all filers, regardless of which exemption scheme they choose. This ensures a uniform, high level of protection for retirement savings nationwide.

What About Rollover IRAs?

This is a very important and often misunderstood area. What happens if you leave an old job and roll your 401(k) (an ERISA-qualified plan) into a Rollover IRA?

The law provides that funds rolled over from an ERISA plan into an IRA retain their unlimited protection and do not count toward the $1,711,975 cap.

However, to make this protection clear to the court and the trustee, it is highly advisable to keep those rollover funds in a segregated Rollover IRA. If you commingled your 401(k) rollover with your own annual IRA contributions, it can become a difficult accounting task to prove which funds are which. A trustee may challenge the protection, creating a legal headache you do not need.

The Major Exception: Inherited IRAs

There is one type of retirement account that receives almost no protection in bankruptcy: an Inherited IRA.

In 2014, the U.S. Supreme Court, in the case of Clark v. Rameker, ruled unanimously that IRAs inherited from someone other than a spouse are not “retirement funds.” The court’s reasoning was that the person who inherited the account cannot contribute to it, can withdraw from it at any time, and is required to take distributions.

Because they are not considered retirement funds, inherited IRAs are treated as any other asset, like a regular bank account. They become property of the bankruptcy estate and can be liquidated by the trustee to pay creditors.

How Do Chapter 7 and Chapter 13 Treat Retirement Funds Differently?

The protection for your retirement accounts is the same in both Chapter 7 and Chapter 13, but the implications of any non-exempt funds can differ.

• In a Chapter 7 Bankruptcy: If you had, for example, $2,000,000 in a Traditional IRA ($288,025 over the federal cap), the trustee would have the right to claim that non-exempt portion, liquidate it, and pay it to your creditors. Your ERISA plans (401k, etc.) would remain untouched.
• In a Chapter 13 Bankruptcy: You do not lose any assets. Instead, you propose a 3- to 5-year repayment plan. However, your plan must pay your unsecured creditors at least as much as they would have received in a Chapter 7. This is called the “best interest of the creditors” test. Using the same example, you would get to keep your $2,000,000 IRA, but you would be required to pay that non-exempt $288,025 to your creditors through your monthly plan payments.

I Have a 401(k) Loan. How Does That Work in Bankruptcy?

A 401(k) loan is technically a “debt to yourself.” Because the money is from your own retirement fund, it is not a “debt” that can be discharged in bankruptcy.

• You cannot be forced to repay it by the court, but if you stop paying, it will be treated as a taxable distribution, and you will owe taxes and penalties.
• Most people choose to continue paying their 401(k) loans during and after bankruptcy to protect their own savings.
• In a Chapter 13, the 401(k) loan repayment can sometimes be factored into your monthly expenses, which can be a complex calculation best handled by an attorney.

Must I List My Retirement Accounts When I File?

Yes. Absolutely.

The entire U.S. bankruptcy system is built on the foundation of full and honest disclosure. When you file, you must sign your schedules under penalty of perjury, listing everything you own and everything you owe.

Hiding a retirement account is a serious mistake that constitutes bankruptcy fraud.

The consequences are severe and can include:

• Denial of your discharge (meaning you still owe all your debts).
• Dismissal of your case.
• In some cases, federal criminal charges.

You must list all accounts, even if they are fully protected. Your attorney will then list the appropriate federal exemption to ensure the trustee cannot touch them. Honesty is not just the best policy; it is the only one.

Critical Mistakes to Avoid with Retirement Funds Before Filing

Faced with financial panic, people often make unforced errors. If you are considering bankruptcy, do not do any of the following:

• Do Not Liquidate Your 401(k) to Pay Creditors. This is the most common and tragic mistake. You would be taking a fully protected asset and using it to pay debts (like credit cards) that could be discharged in bankruptcy. You also get hit with massive taxes and penalties, turning a protected asset into nothing.
• Do Not “Hide” Money in an IRA. Suddenly transferring thousands of dollars from a non-exempt checking account into an IRA right before filing is a red flag for the trustee. This can be seen as a “fraudulent transfer” intended to hinder creditors, and the trustee can undo the transaction.
• Do Not Panic and Do Nothing. Ignoring the problem while debt collectors drain your bank accounts is not a solution. The best time to get advice is before you have made any irreversible moves.

Navigating Your Financial Future with Confidence

The interaction between Alabama bankruptcy laws and federal retirement protections is complex. While most retirement savings are safe, a single misstep—like commingling funds or failing to disclose an account—can create serious complications. Protecting your future requires a clear and accurate strategy. If you are struggling with debt and are worried about your financial future, do not leave your retirement savings to chance. The dedicated team at Padgett & Robertson is here to provide the clarity you need. We can review your specific assets, explain how the law applies to your 401(k)s, IRAs, and other accounts, and guide you through every step of the process.

We help clients across Alabama find solutions to complex financial problems. Contact us at (800) 303-1416 for a confidential consultation to explore your options and protect your hard-earned future.