How to Protect Your Bank Accounts in Bankruptcy

Protecting bank account funds is a priority for most people filing for Chapter 7 or Chapter 13. How bankruptcy will affect your cash or bank account deposits will depend on whether a bankruptcy exemption protects the money.

Can You Exempt Bank Account Funds in Bankruptcy?

In bankruptcy, you can protect "exempt" property. If an exemption covers the funds in your bank account, you won't have to worry about losing the money in Chapter 7 or paying to keep it through your Chapter 13 repayment plan. If an exemption doesn't cover part of your cash or bank account deposits, you might be able to use it for necessities before filing for bankruptcy.

How to Exempt Deposit Accounts in Bankruptcy

Each state has a different set of bankruptcy exemptions, so keeping your bank account will depend on where you live, the funds' value, and the exemptions available to you. When reviewing your state's exemptions, you'll want to look for an exemption that covers either:

• cash
• a deposit account generally, or
• a specific type of account, like a certificate of deposit (CD) account.

Most states don't allow filers to protect much cash or account funds. When a state has this type of exemption, the amount is often minimal—$300 is relatively standard.

Also, it's essential to be sure that any deposit account fund exemption you use covers the balance in your bank account at the time of filing. The trustee responsible for your case will not consider outstanding checks or automatic withdrawals. Learn more about what happens to bank accounts in Chapter 7.

Protecting Bank Accounts With a State Wildcard Exemption

Another option is checking whether your state offers a wildcard exemption. A wildcard exemption allows you to protect any property of your choosing up to a particular value. However, some states limit the application by excluding specific property, such as real estate equity. Also, some states don’t allow wildcard exemptions to be used for account funds, but that's the exception, not the rule.

Protecting Bank Accounts With a Federal Wildcard Exemption

Over half of states let filers choose between the state and federal exemptions. If you have this option, it's worth exploring because the federal wildcard exemption is often more generous than state wildcard exemptions.

One drawback is that it's a take-it-or-leave-it proposition. You must decide which system protects the most property or the assets most important to you because you must use all state or federal exemptions.

Protecting Bank Account Balances by Spending Funds

You can always use your funds to purchase necessities like food, housing, clothing, and medical care. If you're worried about losing money because you can't exempt it, spend it appropriately before filing for bankruptcy. Just be sure to keep good records so you’re ready to respond to any questions the bankruptcy trustee might have about your actions.

Protecting Bank Accounts by Avoiding Set Offs and Freezes

Be careful if you owe your bank or credit union any money when you file for bankruptcy, such as overdraft amounts and past-due fees. You might also have a problem if your bank or credit union has extended credit to you for a personal loan, mortgage, or credit card.

The institution has the right to "set off" the debts owed to it against any bank account funds you have with them. Banks and credit unions can set off your accounts anytime, regardless of whether you file for bankruptcy.

You’ll want to take precautions against your bank exercising its set off rights before filing for bankruptcy because it does happen, and you don’t want to find your account drained unexpectedly. The best way to avoid a set off is to open and use an account in a bank or credit union you don’t owe money.

It's also possible that your bank will "freeze" your account once you file for bankruptcy. Several banks and credit unions do this to preserve account funds until the bankruptcy trustee decides whether the funds belong to the bankruptcy estate.

The quickest way to remedy the problem is by asking the trustee to instruct the bank to release the funds. Otherwise, you’ll need to file a motion asking a judge to release the account, which could take several weeks.

However, the best precaution is to spend the funds on necessary items before filing for bankruptcy. With this approach, you won’t need to worry about a frozen balance or exempting funds.

Converting Bank Account Funds into Exempt Bankruptcy Assets

Prebankruptcy planning or asset conversion are terms used to describe converting nonexempt assets to exempt assets to protect as much property as possible from creditors. In the context of bank accounts, this would amount to using funds over the exemption amount to purchase or invest in exempt assets.

Important note. Whether prebankruptcy planning is legal or appropriate isn’t fully clear. Bankruptcy doesn’t allow you to attempt to hinder, delay, or defraud creditors by taking steps to avoid paying them. If the bankruptcy court believes you intended to defraud creditors with asset conversion, it could impose civil or criminal penalties. To avoid problems, consult a local bankruptcy attorney who is familiar with what your local court considers appropriate asset conversion.

Learn whether you should cash out a retirement account before bankruptcy.