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Filing Bankruptcy in Retirement? What You Need to Know

Ideally, by the time you reach retirement age, you’ll have accumulated enough savings to sustain a comfortable standard of living. Unfortunately, that’s not always the case for seniors who find themselves entering their golden years saddled with debt. Faced with mounting medical bills or staggering credit card balances, retirees are increasingly turning to filing bankruptcy in retirement to remedy their financial woes. While it can provide some relief to cash-strapped seniors, there are some potential downsides.

Find out now: How much do I need to save for retirement?

Choosing a Chapter

There are two basic types of consumer bankruptcy protection: Chapter 7 and Chapter 13. In a Chapter 7 filing, there’s no limit on the amount of debt you can wipe out, but you may have to hand over certain assets to the bankruptcy court before your case is discharged. The trustee responsible for overseeing your case liquidates these assets and uses the proceeds to pay your creditors. When you file Chapter 13, you get to keep all your assets, but you have to commit to repaying a certain amount of debt over a three-to-five-year period.

Qualifying for Bankruptcy in Retirement

Before you can file a Chapter 7 petition, you first have to pass a means test, which is a measure of your ability to repay your debts based on how much you owe and what your median household income and monthly expenses are. The good thing about filing Chapter 7  is that Social Security benefits aren’t considered as income for the means test. That can make qualifying easier if you have income from other sources, like a pension or retirement savings account. If you have too much disposable income to pass the means test, however, you’ll have to look at filing Chapter 13 instead.

Find out now: How much will I get in Social Security benefits?

Assets and Exemptions

One of the things seniors should weigh carefully when contemplating bankruptcy in retirement is how it will affect their assets. Every state has specific laws governing what you can exempt from a bankruptcy case, and depending on where you live you may have the option of substituting federal exemption guidelines. Generally, the kinds of things you can exempt include property, work-related equipment, vehicles, clothing and home equity. There are specific dollar amounts associated with each exemption.

Retirees who own their home need to pay particular attention to the rules regarding homestead exemptions in their state. Some states allow you to exempt any amount of equity while others only permit you to exclude a relatively small amount of your home’s value. The homestead exemption is currently capped at $22,975 under the federal rules. If you’ve built up a substantial amount of equity in your home but live in a state with a low exemption limit, completing your bankruptcy case may require selling the property.

Retirement Assets and Bankruptcy

The good thing about filing bankruptcy in retirement for seniors is that your retirement accounts are usually left intact after your case is discharged. Assets such as 401(k) plans, 403(b) accounts, pensions and profit-sharing plans are fully exempt under federal law. If you’ve got money stashed away in a traditional or Roth IRA, the exemption is capped at $1,245,475 as of 2014.

At the state level, the amount you can exempt varies. Generally, seniors can also claim an exemption for specific types of income, including certain life insurance payments, alimony, veteran’s benefits, disability or illness benefits and public assistance.

Is It the Right Move?

Filing bankruptcy in retirement makes sense if you’ve racked up a substantial amount of unsecured debt and don’t have enough disposable income to cover your monthly payments. Aside from looking at what assets you stand to lose, seniors also need to keep in mind how a bankruptcy filing will affect their credit.

A Chapter 7 filing can stay on your credit for up to 10 years. It’ll take some time for your credit score to rebound from bankruptcy. On the other hand, if you’re looking for a fresh start in retirement, the damage to your credit may seem like a small price to pay.

Tips for Dealing with Bankruptcy 

  • Think carefully about your options and how declaring bankruptcy will affect your assets. Remember that retirement plans, such as your 401(k) plan or IRA, are typically fully exempt under federal law.
  • Once you’re back on your feet, consider signing on to work with a financial advisor to ensure you don’t get off track again. A matching tool like SmartAsset’s SmartAdvsior can help you find a person to work with to meet your needs. First you’ll answer a series of questions about your situation and goals. Then the program will narrow down your options from thousands of advisors to up to three registered investment advisors who suit your needs. You can then read their profiles to learn more about them, interview them on the phone or in person and choose who to work with in the future. This allows you to find a good fit while the program does much of the hard work for you.

Photo credit: flickr

Rebecca Lake Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children.
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