federal exemptions – Rochester Bankruptcy and Debt Relief

Are Pension or 401k Loans Dischargeable?

A significant percentage of retirement plans, like pensions or 401k plans, allow you to borrow money from individual accounts in case of need. One of the most common situations is debtors borrowing money from their retirement accounts to try to pay back their debts. Unfortunately, if these debtors decide to file bankruptcy, the pension or 401K loans they took out will not be dischargeable in Chapter 7. Further, if a bankruptcy was filed, these retirement accounts could have been protected in their entirety since retirement accounts are fully exempt under either federal or New York exemptions in either Chapter 7 or Chapter 13 bankruptcy.

Bankruptcy court views loans from retirement accounts differently than a credit card, a car loan or a mortgage. When you borrow from your retirement account, you are essentially borrowing from yourself, and as result, the loan is not considered dischargeable in Chapter 7 bankruptcy. However, these loans can possibly be included in a Chapter 13 bankruptcy repayment plan, and any amount not repaid at the completion of the 3-5 year plan will typically be discharged. If you have already taken a loan against a pension or 401k account, then Chapter 13 might be the best option, depending on other factors. For many debtors, a pension or 401k account are their biggest assets that should be protected and a bankruptcy filing prior to borrowing money from those accounts would do that.

While borrowing from retirement funds is often seen as a last resort, it should not be. There could be a good reason to borrow against a retirement account in a healthy financial situation, but as a desperate effort to pay bills, borrowing from a pension or 401K will do more harm than good. Realize that if you are considering taking a loan against a retirement account that you have already reached the last straw. Discussing your bankruptcy options should really be the next step.

If you contemplating filing Chapter 7 Bankruptcy or Chapter 13 Bankruptcy, or are dealing with debt problems in Western New York, including Rochester, Canandaigua, Brighton, Pittsford, Penfield, Perinton, Fairport, Webster, Victor, Farmington, Greece, Gates, Hilton, Parma, Brockport, Spencerport, LeRoy, Chili, Churchville, Monroe County, Ontario County, Wayne County, Orleans County, Livingston County, and being harassed by bill collectors, and would like to know more about how bankruptcy may be able to help you, contact me today by phone or email to schedule a FREE initial consultation with a Rochester, NY, bankruptcy lawyer.

Health Savings Accounts, Flexible Spending Accounts and Bankruptcy

In the last few years, especially since Affordable Care Act became law, Health Savings Account (“HSA”) or Flexible Spending Account (“FSA”) became a lot more popular as consumers are dealing with ever rising costs of health care. However, a debtor’s funds held in an HSA or FSA do not appear to be exempt under either New York state exemption law or Section 522 of the Bankruptcy Code. This means that a bankruptcy trustee may pursue debtor’s Health Savings Account or Flexible Spending Account, unless those funds are otherwise exempt.

A Health Savings Account is a tax-exempt account funded by a debtor, his employer or both, to be used to pay the debtor’s medical expenses that are not covered by health insurance such as co-pays or deductibles. The debtor owns the account, and, if debtor changes jobs, can be moved elsewhere. In addition, the funds can accumulate over time and do not have to be used at any particular time. When funds from a Health Savings Account are used to pay medical expenses, it is not treated as income to the debtor.

New York does not provide a specific exemption statute for a Health Savings Account. The most common argument for exemption is that a Health Savings Account is similar to a retirement fund and therefore is exempt for the same reasons that retirement funds are. However, in New York a “retirement fund” is exempt only if “qualified” for tax-exempt status under Internal Revenue Code (“IRC”) sections 401, 402, 403, 408, 408A, 414, 457 or 501(a). Since the tax status of a Health Savings Account is governed by IRC § 223(d), this argument fails. Another argument is that a Health Savings Account is similar to a health aid, and should be exempt for that reason. However, the list of health aids exempt in New York is a very narrow one covering essentially prosthetics and guide dogs, and HSA’s do not appear on the statutory list. If a New York debtor does not claim a homestead exemption, the state “wild card” exemption of $1,000.00 can be applied to protect an HSA, but any funds above that $1,000.00 figure would be available for the Chapter 7 Trustee.

Similarly, there is no specific exemption to claim Health Savings Accounts under federal bankruptcy law. Since a Health Savings Account is not created “on account of illness, disability, death, age or length of service”, and its tax-exempt status is not derived from IRC sections 401, 402, 403, 408, 408A, 414, 457 or 501(a), it is not exempt as a retirement fund. Further, only “professionally prescribed health aids” are exempt under the federal scheme. A fund established by the debtor to pay non-insured medical expenses would not be deemed “prescribed” by a medical professional, so an HSA is not exempt under this section either. If the debtor has it available, federal “wild card” exemption can be used to exempt up $12,725.00 in any asset, including an HSA. Any funds above the “wild card” exemption figure would also be available for the Chapter 7 Trustee.

A Flexible Spending Account (“FSA”) is a tax-deferred savings account established by an employer to pay a debtor’s medical expenses not paid by insurance. Money withdrawn from an FSA to pay for a debtor’s qualified medical-related expenses is also tax-free. Unlike an HSA, funds in an FSA are forfeited to the employer if not used in the benefit year. It appears that a Flexible Spending Account would be treated in bankruptcy court similarly to Flexible Spending Accounts.

Homestead Exemption and Married Spouses

It is not uncommon for one spouse to seek bankruptcy relief under Chapter 7 or Chapter 13 of the Bankruptcy Code in a situation where title to the real property is held in both parties’ names. Generally, under such circumstances, the debtor typically claims a half interest in the property. Thus, the homestead exemption, under either New York law or federal bankruptcy exemptions, would be used to protect that interest. This creates an interesting legal issue since under New York’s Real Property Law both spouses hold an undivided interest in the entirety of the property. If so, does the homestead exemption have to protect all of the equity in the property?

In In re Naples, W.D.N.Y. Bk #14-10264, the bankruptcy trustee made precisely that argument. The trustee argued that since only one of the spouses had filed bankruptcy, and since the property was held by the parties as tenants by the entirety, creating undivided interest in each spouse, the debtor did not have sufficient homestead exemption to protect his equity in the property. The bankruptcy court disagreed. It held that under those circumstances, for purposes of valuing the debtor’s interest in the property, only one half interest needs to be valued and homestead exemption would be applied only to that half interest. The court reasoned that since the way the title is held creates limitations on each spouses to transfer title without consent of the other spouse, for the bankruptcy court’s valuation, only one half interest needs to be valued.

I think that this is a well thought-out result. If both spouses were filing for bankruptcy, each spouse would be able to apply their own exemption to any equity in the property, so if only one spouse files, that spouse should only need to protect that spouse’s half interest.

Bankruptcy Planning, Debt and 401(k)

Once in a while, I hear from debtors who tells me that they expended all or nearly all of their retirement savings trying to avoid bankruptcy. Unfortunately, if you spend your retirement funds trying to avoid bankruptcy, you cannot get it back. If, ultimately, the use of those retirement funds was insufficient to avoid bankruptcy, that money was simply wasted if the debtor still needs to file either Chapter 7 or Chapter 13 bankruptcy.

As I have written previously, 401(k) and most other retirement plans are exempt in bankruptcy. What that means is that if the debtor engaged in some bankruptcy planning and filed bankruptcy before withdrawing retirement funds, the debtor would be able to keep those retirement funds and discharge his or her debts.

I understand why debtors spend their retirement money on debts that would otherwise be dischargeable in bankruptcy. Usually, they want to repay their debts and they will employ any available means to do so. While most debtors are aware of bankruptcy as an option, most debtors try to avoid it.

Since bankruptcy gives you a chance to discharge your debt and protect the assets such as retirement funds, it may be foolish to spend all of your retirement money, and I advise debtors to explore their options before making these decisions. The most important question that the debtors should ask and answer is whether their necessary and reasonable living expenses and debt payments exceed their take home income on a regular basis. If so, is this going to change because of increased income or decreased expenses in the foreseeable future?

If the debtor is left with a permanent deficit and does not expect it to change, then it does not make sense to withdraw retirement funds to continue to pay down that deficit until there is no retirement money left. The bankruptcy system, both New York and federal exemptions, protects your retirement funds.

If you are contemplating filing Chapter 7 Bankruptcy or Chapter 13 Bankruptcy, or are dealing with debt problems in Western New York, including Rochester, New York, Canandaigua, Brighton, Pittsford, Penfield, Perinton, Fairport, Webster, Victor, Farmington, Greece, Gates, Hilton, Parma, Brockport, Spencerport, LeRoy, Chili, Churchville, Monroe County, Ontario County, Wayne County, Orleans County, Livingston County, and being harassed by bill collectors, and would like to know more about how bankruptcy may be able to help you, contact me today by phone or email to schedule a FREE initial consultation with a Rochester, NY, bankruptcy lawyer.

Should 401k Loans Be Used to Avoid Bankruptcy?

Once in a while I am asked whether 401k loans should be used to pay off credit card debt and, therefore, avoid bankruptcy. In my opinion, it is a bad idea.

Filing for bankruptcy under either Chapter 7 or Chapter 13, is a difficult decision, and most of the time debtors will try to do just about anything to avoid filing. However, if you earn $50,000 in gross income, and you are $50,000 in debt, because of interest and other carrying costs, it is unlikely that you will be able to pay off that debt within a reasonable period of time. Thus, a debtor may think that whatever money he has in his 401k will save him from having to file bankruptcy. Unfortunately, for most people, this is unlikely to come true.

Initially, if 401k loan is used to pay off credit card debts, there is now a significant debt owed to the 401k plan. Usually, 401k loans carry lower interest rates than credit cards. However, while having a lower interest rate, 401k loans have to be paid back over a shorter period of time.

If a loan is taken out and not repaid, it is treated as income, and debtor will incur a 10% early withdrawal penalty since it is a distribution from a tax-deferred plan, and also will have to pay income taxes on the unpaid amount. Unpaid amount of the loan is treated as additional income, and it is likely to increase debtor’s income tax rates as well.

If you quit working or change employers, the loan must be paid back right away. It’s not uncommon for plans to require full repayment of a loan within 60 days of termination of employment. If you can’t repay the loan, it is considered defaulted, and you will be taxed on the outstanding balance, including an early withdrawal penalty if you are not at least age 59 ½.

However, if the debtor decides to file bankruptcy, under either Federal exemptions or New York exemptions, 401k is completely exempt. If you file for bankruptcy, the credit card debt will be gone, and you will be able to retain the money in your 401k plan.

If you are contemplating filing Chapter 7 Bankruptcy or Chapter 13 Bankruptcy, or are dealing with debt problems in Western New York, including Rochester, Canandaigua, Brighton, Pittsford, Penfield, Perinton, Fairport, Webster, Victor, Farmington, Greece, Gates, Hilton, Parma, Brockport, Spencerport, LeRoy, Chili, Churchville, Monroe County, Ontario County, Wayne County, Orleans County, Livingston County, and being harassed by bill collectors, and would like to know more about how bankruptcy may be able to help you, contact me today by phone or email to schedule a FREE initial consultation with a Rochester, NY, bankruptcy lawyer.

Under the New Law, Federal Bankruptcy Exemptions Are Available In New York

As I have written previously, the new exemption law permits New York residents to choose between the New York exemption statutes and the Federal Exemption that are set forth in Section 522(d) of the Bankruptcy Code.

The federal exemptions have never been available to debtors filing Chapter 7 and Chapter 13 Bankruptcy in New York before because New York chose to opt out of the federal exemptions statute in the past.

The federal exemptions have different provisions that may be more favorable for individual debtors than New York’s statutory exemptions. They may allow debtors and their bankruptcy attorneys to protect certain assets that may not be available under New York’s statutory exemptions, provided that debtors do not need to take advantage of their homestead exemption.

The federal exemptions contain a “wild card” exemption that enables consumers to protect a substantial amount of cash, well in excess of New York’s statutory limit.

Specifically, the federal exemptions are as follows:

(1) The debtor’s aggregate interest, not to exceed $21,625 in value, in real property or personal property that the debtor or a dependent of the debtor uses as a residence, in a cooperative that owns property that the debtor or a dependent of the debtor uses as a residence, or in a burial plot for the debtor or a dependent of the debtor.

(2) The debtor’s interest, not to exceed $3,450 in value, in one motor vehicle.

(3) The debtor’s interest, not to exceed $550 in value in any particular item or $11,525 in aggregate value, in household furnishings, household goods, wearing apparel, appliances, books, animals, crops, or musical instruments, that are held primarily for the personal, family, or household use of the debtor or a dependent of the debtor.

(4) The debtor’s aggregate interest, not to exceed $1,450 in value, in jewelry held primarily for the personal, family, or household use of the debtor or a dependent of the debtor.

(5) The debtor’s aggregate interest in any property, not to exceed in value $1,150 plus up to $10,825 of any unused amount of the exemption provided under paragraph (1) of this subsection.

(6) The debtor’s aggregate interest, not to exceed $2,175 in value, in any implements, professional books, or tools, of the trade of the debtor or the trade of a dependent of the debtor.

(7) Any unmatured life insurance contract owned by the debtor, other than a credit life insurance contract.

(8) The debtor’s aggregate interest, not to exceed in value $11,525 less any amount of property of the estate transferred in the manner specified in section 542(d) of this title, in any accrued dividend or interest under, or loan value of, any unmatured life insurance contract owned by the debtor under which the insured is the debtor or an individual of whom the debtor is a dependent.

(9) Professionally prescribed health aids for the debtor or a dependent of the debtor.

(10) The debtor’s right to receive–

(A) a social security benefit, unemployment compensation, or a local public assistance benefit;

(B) a veterans’ benefit;

(D) alimony, support, or separate maintenance, to the extent reasonably necessary for the support of the debtor and any dependent of the debtor;

(E) a payment under a stock bonus, pension, profitsharing, annuity, or similar plan or contract on account of illness, disability, death, age, or length of service, to the extent reasonably necessary for the support of the debtor and any dependent of the debtor, unless–

(i) such plan or contract was established by or under the auspices of an insider that employed the debtor at the time the debtor’s rights under such plan or contract arose;

(ii) such payment is on account of age or length of service; and

(iii) such plan or contract does not qualify under section 401(a), 403(a), 403(b), or 408 of the Internal Revenue Code of 1986.

(11) The debtor’s right to receive, or property that is traceable to–

(A) an award under a crime victim’s reparation law;

(B) a payment on account of the wrongful death of an individual of whom the debtor was a dependent, to the extent reasonably necessary for the support of the debtor and any dependent of the debtor;

(C) a payment under a life insurance contract that insured the life of an individual of whom the debtor was a dependent on the date of such individual’s death, to the extent reasonably necessary for the support of the debtor and any dependent of the debtor;

(D) a payment, not to exceed $21,625, on account of personal bodily injury, not including pain and suffering or compensation for actual pecuniary loss, of the debtor or an individual of whom the debtor is a dependent; or

(E) a payment in compensation of loss of future earnings of the debtor or an individual of whom the debtor is or was a dependent, to the extent reasonably necessary for the support of the debtor and any dependent of the debtor.

(12) Retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under section 401, 403, 408, 408A, 414, 457, or 501(a) of the Internal Revenue Code of 1986.

Here is an example of how a typical debtor may benefit from using Federal exemptions. If debtor owns a motor vehicle that has $6,000.00 in equity, under the New York exemptions, debtor can only protect $4,000.00 of that equity (plus the New York wildcard exemption, if available). However, if debtor uses the Federal Exemptions, debtor can COMBINE the wildcard exemption with the standard Federal auto exemption of $3,450.00, and use an additional $2,550.00 of the wildcard exemption to protect the remaining equity in that vehicle. As long as debtors do not need to use homestead exemption in excess of the Federal Homestead Exemption of $21,625.00, debtors are likely to benefit from the Federal Exemptions.

Changes to New York’s Bankruptcy Exemptions

Back in July I have written about a pending bill which would have changed New York’s bankruptcy exemptions and allowed debtors to use the current federal exemptions or the exemptions in New York Law. At the time, it was impossible to predict whether the bill would ever become law.

On December 23, 2010, the bill was signed into law and will become effective in 30 days. This is the biggest change in New York’s bankruptcy exemptions in years, and will make a tremendous impact on the debtors filing both Chapter 7 Bankruptcy and Chapter 13 Bankruptcy.

Homestead Exemption Increases to $75,000 per person for those in Rochester and Western New York

Right now each homeowner can protect only $50,000 worth of equity in a house. However, for those living in Rochester and Western New York Counties, that amount will increase to $75,000. Since a married couple can combine their exemptions, that means that a couple will be able to protect a$150,000 worth of equity in their home.

This will enable almost any typical Rochester middle class family to file bankruptcy to eliminate their credit card debts while protecting their home. In my Rochester, New York, bankruptcy practice, I periodically meet with homeowners who are forced to file for Chapter 13 Bankruptcy instead of Chapter 7 Bankruptcy because they have too much equity in their homes. Now, almost everyone will be able to seek Chapter 7 Bankruptcy relief and keep and protect their homes.

Amounts for Almost All Other New York’s Exemptions Categories Are Being Increased and New Categories Are Being Added

The new law also increases the exemptions for many other assets such as cars, and adds some new categories like home computers and vehicles for the handicapped.

Comparison of New York’s Old and New, 2011 Bankruptcy Exemption Statutes

Existing New York State Bankruptcy Exemptions

NEW New York State Bankruptcy Exemptions

Homestead Exemption (note: this can be combined for married couples filing jointly, who own the real estate together)

$50,000

Homestead Exemption (note: this can be combined for married couples filing jointly, who own the real estate together)

$150,000 for property in the downstate New York (Counties of Nassau, Suffolk, Kings, Queens, Bronx, Richmond, Rockland, Westchester and Putnam)

$125,000 for property in the Counties of Dutchess, Albany, Columbia, Orange, Saratoga and Ulster

$75,000 for all other counties

Motor Vehicle

$2,400

Motor Vehicle

$4,000

Motor Vehicle equipped for use by a disabled person (new category)

$10,000

Cash Exemption if Homestead Exemption is taken

None

Cash Exemption if Homestead Exemption is taken

$1,000. (Note: New exemption. Can also be used for personal property. However, the Federal Exemption is much greater and allows debtors to protect much more in appropriate situations.)

Jewelry and Art

a wedding ring

a watch worth up to $35

Jewelry and Art

a wedding ring

a watch, jewelry and art worth up to a total of $1,000 (Notes: New exemption. This will make it much more difficult for trustees to seek payment for engagement rings)

Tools of Trade (these are the working tools and implements that are necessary to carry on one’s business)

$600

Tools of Trade (these are the working tools and implements that are necessary to carry on one’s business)

$3,000

Aggregate Individual Bankruptcy Exemption for Cash, Household Goods and Clothing

$5,000

Aggregate Individual Bankruptcy Exemption for Cash, Household Goods and Clothing

$10,000

The New and Increased Exemptions Will Benefit Future Bankruptcy Debtors

Not only will more consumers be able to file for Chapter 7 Bankruptcy, but it will also help those debtors filing Chapter 13 Bankruptcy since they may be paying substantially less through their monthly Chapter 13 plan. In addition, existing Chapter 13 Bankruptcy debtors may be able to convert their cases to Chapter 7 and eliminate all future monthly payments.

I have attached a copy of the actual bill here.