How Does Bankruptcy Work?

Bankruptcy may be the only solution if you find yourself piled debt with no way out. Since it is a tedious process with very serious and real consequences, understanding how bankruptcy works before following through is necessary. Also, not all debt can be cleared and filing bankruptcy will have an effect on your credit for a very very long time.

thebankruptcyTypes of bankruptcy

There are many types of bankruptcy. Some are designed for businesses (Chapter 11) while others are for individuals (Chapter 7, 13). Chapter 7 bankruptcy is called liquidation bankruptcy. When you file for this type of bankruptcy any unsecured debts are erased. Chapter 13 bankruptcy works differently as it allows you to recognize your debts by creating a repayment plan with lenders. When you file a Chapter 13 bankruptcy you are able to keep the things that you own so this option can be better for some individuals.

Who can claim bankruptcy?

Filing for chapter 7 or chapter 13 bankruptcy depends on a lot of factors. A chapter 7 bankruptcy can be filed by individuals and businesses and only be filed if your income is not enough to repay your debts on a payment plan. Chapter 13 bankruptcy can only be filed by individuals and be claimed if you have less than $383K in unsecured debt or less than 1.1MM in secured debt.

What happens to the debts?

Chapter 7: Most unsecured debts are eliminated and any assets that you have are sold. Assets such as clothing and cars are usually exempt from repossession. Any secured debts you have (ie: car loan or mortgage) can be exchanged for the item that is used to secure the loan or you can arrange a repayment plan.

Chapter 13: You will work with your creditors to set up a payment plan that states how much you will pay and how long it will take to pay your debts back.

And then what happens?

Bankruptcy does not provide you with a clean state even though is can help you get your finances back on track. The bankruptcy will stay on record for up to 10 years and will make getting any new credit extremely difficult. A personal financial management course is also mandatory to teach you the skills you need to manage your money.

What are my other options?
Debt consolidation is a good option for people who find themselves in a great deal of debt. There are counselors and companies that you can go to which can help you consolidate your debts. You can also work on a repayment plan with creditors on your own, saving you from having to file bankruptcy. Bankruptcy is not a quick fix and while it may help you, it’s not always the best option. In the long run it will hurt your credit for a very long time and make it near impossible to get any new credit for years.

In a Damaged Economy, Can I Lose My 401(k) if My Company Files Bankruptcy?

For quite some time now, the state of the economy has been a cause for concern on a variety of fronts, but one of the biggest concerns voiced was for the future of many individual’s 401(k) plans. After all, the vitality of these funds depends heavily upon the company’s performance that it is tied to, as well as the individuals association with that company—with so many being laid off, how could concern not flow freely?


Photo by Tax Credits on Flickr

One of the best cures for concern, fear, and every emotion of its kind, though, is knowledge. The best thing that you can do to protect yourself, as well as your 401(k), is to be prepared and to know your options.

In order to assist in this endeavor, below is a list of commonly asked questions about this concern for you to consider, with answers you can add to your knowledge-base. If you want to find out more about how you may be affected, you can check out the Suncorp superannuation calculator.

Q: What happens to my 401(k) if my employer goes bankrupt?
The answer to this question largely depends upon what kind of bankruptcy your employer has filed; it will either be a Chapter 11 or a Chapter 7 bankruptcy. Both will render different results.

Q: What happens as a result of a Chapter 11 bankruptcy?
When this bankruptcy is filed, your employer intends to restructure all of their assets in order to overcome their financial depression. During this restructuring, 401(k) plans may continue on; however, if part of the restructuring is to cut back on benefits, you may lose any matching contributions the company may have made if you’re outside of your company’s designated vesting period.

Q: What happens as a result of a Chapter 7 bankruptcy?
When this bankruptcy is filed, you employer intends to liquidate; when this happens, your 401(k) plan has a high probability of being terminated.

Q: Is there any kind of protection for my 401(k), should a Chapter 7 occur?
Yes; under the Employee Retirement Income Security Act (ERISA) of 1974, the funds held within your 401(k) account must be held separate from company assets and must be protected from creditors; typically, they’re held within a trust or insurance account for safekeeping.

It’s important to keep in mind, however, that any payroll deductions your employer hasn’t yet sent over to the 401(k) will not be recovered.

Q: How often does my employer transfer deductions to my 401(k)?
Your employer is required to transfer all payroll deductions into their individual 401(k) accounts no later than 15 business days past the end of the month within which they were drawn.

Matching contributions that your employer may have been making sometimes occur less frequently (i.e. quarterly, semi-annually, or annually) and therefore might not make the transfer before the bankruptcy occurs.

It’s a good idea to regularly check your 401(k) account statements to monitor this activity, but if your 401(k) comes up a bit short due to bankruptcy, you’ll probably find that the deductions from your most recent paycheck never made it through.

Q: What happens if my 401(k) funds are distributed to me before I reach the age of 59.5 due to company bankruptcy? Am I required to pay taxes on the funds in the account?
If you decide to keep the funds, yes, you will have to pay the same taxes and penalties that you would have paid had you withdrawn your 401(k) before the designated retirement age. You can avoid this, however, by simply rolling the funds from the account over into a new account with a new employer, continuing your 401(k) plan with little, to no, financial interruption.