What happens to a retirement plan loan in bankruptcy?

Which loans does this cover?

The rules apply to a loan owed to a pension, profit-sharing, stock bonus or similar retirement plan set up under the tax code, and to a loan from the federal Thrift Savings Plan. In everyday terms, it is money you borrowed from your own retirement savings at work and repay to the plan.1 2

The IRS says profit-sharing, money purchase, 401(k), 403(b) and 457(b) plans may offer loans to participants, while IRAs cannot. If you are not sure what kind of plan or loan you have, your plan administrator can tell you.5

What happens to the loan in Chapter 7?

The loan is not discharged. The federal courts list debts owed to certain tax-advantaged retirement plans among the common debts a discharge does not cover.1 2

The repayments do not pause either. The automatic stay stops most collection, but it does not stop your employer from withholding money from your wages, under your own agreement, to repay a loan from an employer-sponsored retirement plan.6 3

What happens to the loan in Chapter 13?

A Chapter 13 plan may not materially alter the terms of a retirement plan loan that is repaid by wage withholding. You keep repaying it on the plan's own schedule.4

This matters for the size of your plan payment. A Chapter 13 plan must commit your projected disposable income to creditors, and the law says the amounts required to repay this kind of loan are not disposable income.8 4

Is the retirement account itself protected?

The account and the loan are separate questions. Exemptions are the rules that let an individual keep certain property from unsecured creditors, and both the federal exemption list and the alternative used by people who claim state exemptions let a debtor exempt retirement funds held in a tax-exempt fund or account of the kinds the law lists.6 9

Which exemption list applies to you depends on state law, and not every account qualifies. Confirm how your own account is treated with a lawyer.9 10

What if you stop repaying the loan?

The tax rules for plan loans are a separate matter from bankruptcy. These points come from the IRS, and a tax professional or your plan administrator can tell you how they apply to you.

• If loan repayments are not made at least quarterly, the remaining balance is treated as a distribution that is subject to income tax and may be subject to the 10% early distribution tax.5
• If you leave your employer and cannot repay the loan, the employer treats it as a distribution.5
• The loan is not discharged in Chapter 7 and cannot be materially altered in Chapter 13, so its terms keep applying after you file.1 2 4

Does it make sense to borrow from a retirement plan before filing?

That is a personal decision, and these are the legal pieces to weigh. Retirement funds in a qualifying account can be claimed as exempt, while a Chapter 7 discharge covers debts that arose before filing unless an exception applies.9 11

Borrowing from the plan to pay those debts turns money that may have been protected into payments on debts that might have been discharged, and it leaves a loan that bankruptcy will not discharge in Chapter 7. It is worth talking to a lawyer before you borrow.1 2