Most debtors need their disability payments to live on while they're unable to work. Fortunately, most disability payments are protected in Chapter 7 bankruptcy and cannot be taken by the bankruptcy trustee. But exceptions exist depending on:
(Find out what happens to Social Security payments if you file for Chapter 13 bankruptcy.)
When you file for bankruptcy, you don't give up everything that you own. You're allowed to keep (exempt) property that you need for your care and to maintain a home. Both federal and state exemption laws protect Social Security disability benefits, so you're typically allowed to keep the payments in Chapter 7 bankruptcy.
For instance, the federal law exempts disability benefits received under the Social Security Act, thereby protecting the payments in bankruptcy proceedings (42 U.S.C. §407). State exemption laws can also protect these assets—and some jurisdictions even exclude disability benefits from the bankruptcy estate altogether, so that the filer doesn't need to claim them as exempt to keep them. (Find out how bankruptcy exemptions work.)
But in most cases, the exemption isn't automatic. When filling out your bankruptcy paperwork, you'll list the benefits as property, as well as the exemption that allows you to keep them. You'll also need to take additional steps to avoid some pitfalls that could result in you losing benefits.
If you are receiving disability benefits from sources other than Social Security, then the amount of payments you can keep depends on where you live. While most states have exemptions that protect disability payments, exemption amounts vary from state to state.
For instance, certain jurisdictions allow filers to protect only the amount necessary for your care and maintenance. So depending on where you live, a Chapter 7 trustee might be able to go after a lump sum disability payment, or any unspent payment amount, if it is not necessary for your support.
To avoid any surprises, consider checking your state's bankruptcy exemptions to determine whether you can keep your disability payments in Chapter 7 bankruptcy before filing your case or meet with a bankruptcy attorney.
The primary role of the Chapter 7 trustee is to find funds to pay to creditors—and the trustee won't agree that you can keep certain property without being convinced that you're entitled to do so. For instance, if you received a lump sum disability payment before filing your case—or even monthly payments that you didn't spend—you will have to provide evidence proving that the funds were from a disability payment before you'll be able to protect the balance using a federal or state exemption.
So why is this a problem?
Most people deposit all of their money into one bank account. This practice of placing funds from different sources into one account that creates a common problem faced by many filers—being able to prove which funds in the pool are disability funds. Once the two sets of funds mix and you make withdrawals, it can be difficult, if not impossible to meet the evidentiary burden. The trustee will likely claim that mixing different funds destroys the ability to exempt the money.
To help avoid this issue, consider dedicating an exclusive account for the disability funds.
If you're concerned about losing your disability funds, you'll want to meet with a knowledgeable bankruptcy attorney. You'll likely learn whether:
(For more on Social Security benefits in bankruptcy, read Can Bankruptcy Take Your Social Security?)
Updated by: Cara O'Neil