Bankruptcy is a common financial strategy that’s often misunderstood.
There’s chapter 11, which businesses and wealthy folks use to reorganize debts and stay afloat, and there’s chapter 13, which lets the debtor keep their property as they repay what they owe, not to mention other chapters for fishermen and foreign debts.
Chapter 7, the most common form of bankruptcy in America, is also known as a liquidation bankruptcy. Unlike chapter 13, your non-exempt property and assets are sold to help repay your debts. Fortunately not everything you owe is taken from you, and pre-bankruptcy planning can help you preserve more of your assets.
Read on to learn about several (legal) ways to protect your money during a chapter 7 bankruptcy:
1. Put money in college accounts
Do you have kids? Some college funds are protected from chapter 7 bankruptcy, particularly Section 529 savings plans, so it could be prudent to add money to these accounts to keep it safe.
Certain states offer some protection even if the fund is in the debtor parent’s name, but not all do.
You get maximum protection from creditors if the account is in your child’s name. The downside is the child will have access to the money when they come of age and can do what they want with it.
If you are concerned your kid might misuse the money, consider putting it in your spouse’s name instead. Protections vary by state, so check the laws where you live.
2. Fund retirement plans
When going through bankruptcy, it’s a good bet your money will stay safe in retirement accounts if it’s under a certain amount.
“Contributions and earnings in your Traditional IRAs and Roth IRAs have an inflation-adjusted protection cap of $1 million from bankruptcy proceedings,” according to Investopedia.
Even better, the bankruptcy court has the ability to increase this cap if they are feeling generous.
Additionally, “Employer-sponsored plan assets have unlimited creditor protection from bankruptcy.” If bankruptcy is around the corner, it’s not a bad idea to add funds to your IRA or 401(k).
Just keep in mind IRA contributions are capped at $5,500 per year ($6,500 if you’re 50 or older).
3. Pay down your mortgage
In some states, there are large homestead exemptions, meaning some or all of your home cannot be taken from you during bankruptcy.
If you know you’re in a state that lets you keep your home, you can preserve some of your assets by paying your mortgage if you don’t own the house outright.
4. Make exempt purchases
During chapter 7 bankruptcies, everything falls into two categories: exempt, meaning it can’t be taken from you, or non-exempt, making it part of your bankruptcy estate.
For more information about homestead and bankruptcy exemption laws in your state, click here.
According to AllLaw.com, you are sometimes allowed to use non-exempt money to make exempt purchases.
To help protect your assets, “Purchase exempt personal property, such as cars, household goods, furniture, clothes or other essential items.” However, exemption amounts vary state to state, so do your research first.
5. Exchange assets
During bankruptcy, you are appointed a trustee to oversee the process.
In some cases, you can offer to exchange a specific non-exempt asset for an exempt asset. This lets you keep something important to you, while still giving the trustee something they can use to pay off your debts.
Note that in some cases, you can also just outright buy the asset back from the trustee if they agree to it.
There are many other strategies for protecting your money during bankruptcy, but they can vary greatly due to state laws, and some can get you in trouble if not handled wisely.
We recommend you work with a bankruptcy lawyer to ensure you are making the best (and legal) financial decisions for your situation.
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