New Bankruptcy Law and Financial Planning

By John Keir

Changes to the Bankruptcy Code went into effect on October 17, 2005. Financial planners may find it interesting that the new law now requires individuals who file for bankruptcy to receive a briefing that outlines the opportunities for credit counseling and that assists the individual in performing a budget analysis. The briefing must be given within 180 days before the bankruptcy filing. After the bankruptcy filing, an individual must also complete a financial management instructional course before discharge.

Chapter 7 bankruptcy, which is used primarily by individuals with consumer debts, will now be subject to a “means test” which determines whether the individual has a level of income that allows for repayment of debts. If the individual has income exceeding median income for the state, creditors can object to the case proceeding in bankruptcy. It is left to the court to decide whether the case should proceed.

Chapter 13 is designed for individuals with regular income who want to pay their debts in installments over a 3 to 5 year period. The amount of the debt may be reduced, but some new provisions have made the amount of reduction less than was previously available. After the payments are completed, the individual receives a discharge. A Chapter 13 bankruptcy is generally used when an individual has fallen into arrears on mortgage payments, car payments, or tax payments and does not want to lose the house, car, or property in question.

Retirement accounts generally benefited from the changes to the law. Qualified plans, which were previously exempt property in many states, are now exempt property in all states. A direct transfer and a rollover of retirement funds are also exempt property. IRAs are exempt property up to $1 million. Loans from retirement plans are not treated as bankruptcy debts, and the repayment of loans by withholding income from the individual’s wages is not stayed by the filing of bankruptcy. . Employer contributions to retirement plans are not counted as income to the employee for purposes of the means testing.

Funds contributed to education individual retirement accounts (now called Coverdell education savings accounts) for a child or grandchild are excluded from bankruptcy if the contributions were made at least one year before the filing for bankruptcy. Similarly, the funds in 529 plans are excluded if the contributions were made at least one year before the filing.

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