Cashing out a retirement account before filing for bankruptcy is almost always a mistake, since most retirement funds are already protected from creditors under federal and state law until withdrawn.
Not if you can avoid it. Most retirement accounts are already protected in bankruptcy, so draining one before you file usually does you more harm than good. A filer can wipe out qualifying debt in Chapter 7 or Chapter 13 and keep a retirement account intact, coming out the other side in a stronger financial position. Bankruptcy attorneys hear it all the time: a new client drained a retirement account to pay bills, only to learn the account would have been safe anyway. Below, we explain why cashing out is usually the wrong move, and what to do instead.
Disadvantages of Cashing Out a Retirement Account Before Bankruptcy
Because retirement accounts enjoy strong protections in bankruptcy, cashing one out before you file usually isn't in your best interest. Doing so means giving up a protected asset to pay debt you could otherwise discharge, or erase, in bankruptcy. Most filers can get through bankruptcy with their retirement account intact, which puts them in a far better position to recover financially once the case ends.
Many Retirement Accounts Are Safe in Bankruptcy
Many people mistakenly believe they'll have to give up almost all their property if they file for bankruptcy. That's not the case. State and federal laws provide bankruptcy exemptions that protect a certain amount of your property, and retirement accounts get some of the broadest protection of all.
ERISA-Qualified Retirement Accounts
Retirement accounts qualified under the Employee Retirement Income Security Act (ERISA) aren't part of your bankruptcy estate at all. You don't need an exemption to keep the trustee from taking the account in Chapter 7, and you don't have to pay anything to keep it in Chapter 13.
ERISA-qualified accounts come with transfer restrictions that shield them from creditors, and those restrictions hold up in bankruptcy. Most employer-sponsored plans, including 401(k)s, 403(b)s, defined-benefit plans, and profit-sharing plans, typically qualify under ERISA. If you're not sure whether your account meets ERISA requirements, ask your employer. Investment, savings, and profit-sharing plans generally aren’t protected under federal laws and are rarely protected under specific state exemptions.
Learn more about a 401(k) in bankruptcy.
Other Retirement Account Exemptions
Traditional and Roth IRAs get a separate federal exemption, currently capped at $1,711,975 per person. (11 U.S.C. § 522(n); amount valid April 1, 2025, to March 31, 2028.) Many states also exempt a certain amount of retirement funds on top of this federal cap.
Other types of retirement accounts can still be protected by federal or state exemptions, but not all are. Watch out for investment accounts in particular; you might think of one as a retirement account, but it may have no bankruptcy protection at all.
You Can Lose Protection by Cashing Out
Once you take funds out of a protected retirement account, that protection can disappear. If you withdraw money to buy other property or move it into a bank account, you lose the special protection retirement funds get in bankruptcy.
From that point on, you'd need to find other bankruptcy exemptions to protect the withdrawn cash or whatever you bought with it. Protecting cash and money in investment and bank accounts in bankruptcy is difficult, and it's easy to make a costly mistake trying.
Early Withdrawal Penalties and Tax Consequences
Cashing out a retirement account can also trigger early withdrawal penalties and a tax bill, on top of losing your bankruptcy protection. If you haven't reached retirement age, you'll likely owe an early withdrawal fee and income tax on whatever you take out.
Talk to a Bankruptcy Attorney Before You Act
Every financial situation is different, and cashing out a retirement account could make sense in rare cases. But it's rarely a good idea before filing for bankruptcy if you can avoid it, and it's almost always a mistake to use those funds to pay debt that bankruptcy would otherwise wipe out. Before you touch a retirement account or any other major asset, talk to a knowledgeable bankruptcy attorney who can walk you through your options and confirm what's protected in your case.
