Bankruptcy and Creditors’ Claims: Self-Directed Solo 401k | Solo 401k

When you as debtor declare bankruptcy, the majority of your assets become part of the bankruptcy estate. The bankruptcy estate then appoints a trustee to manage the bankruptcy estate, who uses assets from the bankruptcy estate to pay off your creditors. However, thanks to the Federal Bankruptcy Code, Self-Directed Solo 401k (also referred by other names such as Solo 401k, Solo k and Individual 401k) is excluded (that is, not subject to creditors claims) from the bankruptcy estate.

Congress passed in 2005 legislation that exempts qualified retirement plan (QRP) assets from bankruptcy estates under federal law (the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005). Further, ERISA (Employee Retirement Income Security Act of 1974) as well as IRC (Internal Revenue Code) detail that in order for a qualified plan such as a self-directed solo 401k to qualify as a retirement plan, it must list anti-alienation language. See ERISA Sec. 206(d) and IRC Sec. 401(a)(13).  

Court Case Supporting Exclusion from Creditors

Supreme Court case, Patterson V. Shumate--The Supreme Court ruled that anti-alienation provisions in the defendant's "ERISA-qualified" retirement plan had to be given effect under the bankruptcy rules. Since ERISA prohibits the assigning of benefits--even to a bankruptcy trustee, the retirement assets in that case were excluded from the bankruptcy estate.

The Bankruptcy Act of 2005

The passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 exempts rather than excludes under federal law, assets in employer-sponsored retirement plans established under IRC Secs. 401, 403, 408A, 414, 457, or 501(a). This law permits a debtor to choose to exempt employer-sponsored retirement plan assets from his or her bankruptcy estate, regardless of whether state or federal bankruptcy law is followed for purposes of exempting assets from the bankruptcy estate.

Solo 401k Plan Participant Loans Not Forgiven

Generally, in a bankruptcy proceeding, certain debtor obligations may be discharged (i.e., forgiven). But plan loans under this exemption are no dischargeable (11 U.S.C. Sec. 362(b)). This means that the loan is not forgiven. Instead, the loan must be either paid back or the outstanding balance treated as a taxable distribution.