Personal Bankruptcy: Making Hard Decisions

For debtors drowning in bills, bankruptcy can seem like the only solution. But they must first exhaust other possibilities first:

1. Speak with a legitimate credit counseling agency.
2. See if they can work something out with their creditors. If they declare bankruptcy, the creditors may get little or nothing, so creditors have an incentive to be flexible.
3. Consider whether they can sell something. Do they need that second car, for example?
4. Can they get a second job? Even a few hours a week can make a difference.

However, sometimes individuals get so deeply in debt that there's no way they can realistically pay it off. They have been unable to negotiate further with their creditors and their liabilities exceed their assets. At that point, they should talk with attorneys and financial professionals about getting a fresh start with bankruptcy.

However, bankruptcy comes with long-lasting and serious implications, so filing should be a last resort. Credit cards and all kinds of loans, including mortgages, may be impossible to obtain for many years. Once the decision is made, the debtors file under either Chapter 7 or Chapter 13, based on their situation and a variety of other factors.

In a Chapter 7 bankruptcy, the court appoints a trustee to liquidate assets to pay creditors according to an established priority list. After the assets are gone, the court discharges the debts — the debtor is not on the hook for them. However, the debtor will likely still have to pay alimony, child support, certain government debts, income taxes and federal student loans.

A Chapter 13 bankruptcy is less severe: Debtors create a plan to reorganize their finances and gradually pay back creditors over three to five years. The court must approve the plan, and the debtor will give the monies to a court-appointed trustee, who will distribute them to the creditors according to the plan. A particular advantage of a Chapter 13 bankruptcy is that it can allow the debtors to retain their homes, if the approved plan includes mortgage payments.

One great advantage of either kind of bankruptcy is that retirement plans are protected. ERISA-governed qualified plans, such as 401(k) plans, are off the table in a bankruptcy proceeding. Debtors can keep them in their entirety. Non-ERISA qualified plans such as IRAs are partially protected — funds under a certain amount (currently about $1.3 million) are safe, but the rest can be used to satisfy debts. Also, debtors who owe back taxes to the government, or alimony or child support, may find the government can seize funds "hidden" in retirement plans.
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This is just a summary of a complex process with many rules and exceptions. The bottom line is that debtors are not financial experts and are further hampered by the emotional turmoil that comes with their situation. They should not make any decisions regarding bankruptcy without talking with qualified professionals, who can dispassionately explain their options.