If you file for Chapter 7 or Chapter 13 bankruptcy, what happens to any loans you may have taken out from your retirement plan or pension fund?
If you have taken a loan from your retirement plan and are considering bankruptcy, two questions may arise.
Read on to learn the details.
Many retirement plans allow plan participants to borrow money from their retirement account to use for certain types of expenses (such as paying for education or buying a home). This early withdrawal is treated like a loan -- the money must eventually be paid back to the retirement plan. Sometimes you can repay the loan through automatic wage withholdings.
Loans from your retirement plan are not discharged in Chapter 7 or Chapter 13 bankruptcy. Although few argued they were dischargeable prior to 2005, in particular because bankruptcy only discharges obligations you owe to others -- and in the case of a retirement plan loan, you owe the loan to yourself.
This was confirmed in 2005, when Congress transformed Section 523(a)(18) of the bankruptcy code to make clear that loans from pension and other retirement funds are not dischargeable in bankruptcy.
When you file a bankruptcy petition, the automatic stay kicks in right away. The automatic stay prevents most creditors from continuing collection efforts against you. The automatic stay extends to wage garnishments – your employer must stop all wage garnishments that were initiated at the behest of a creditor. (To learn more about the automatic stay, see How Bankruptcy Stops Your Creditors: The Automatic Stay.)
However, there are several exceptions to the automatic stay. In 2005, Congress added to the list of exceptions wage withholdings to pay back a loan from a pension fund or retirement plan as long as the plan is ERISA-qualified (most are). This means that the automatic stay does not affect such wage withholdings. When you file for bankruptcy, wage withholdings to repay retirement plan loans will continue uninterrupted.
To learn how other loans and debts are treated in bankruptcy see our Your Debts in Chapter 13 Bankruptcy and What Happens to Your Debt and Property in Chapter 7 Bankruptcy areas.