Typically, someone's retirement funds aren't in danger if that person files for bankruptcy. Retirement funds are generally exempted from bankruptcy proceedings. However, those exemptions may not hold true if the funds were part of the bankruptcy petitioner's divorce settlement.
A ruling by the U.S. Bankruptcy Appellate Panel for the 8th Circuit that affirms a lower court's ruling stands to have a significant effect on divorced individuals who need to file bankruptcy at any point in the future if they're hoping to keep the assets that came from a spouse's retirement plans.
The effect of the ruling could be even worse if the bankruptcy petitioner co-mingled the funds from his or her divorce settlement with his or her own retirement accounts -- something financial advisors have traditionally done. Co-mingling the funds may have the effect of voiding the bankruptcy exemptions for all of them.
The case that resulted in the new ruling involved a man who received money from his ex-wife's 401(k) and IRA plan as part of his divorce settlement. He later filed a Chapter 7 bankruptcy petition and sought to declare the assets received from his ex-wife and his own retirement funds exempt, or not subject to claims by his creditors.
The bankruptcy court disagreed, and the new ruling solidifies that decision.
The ruling has an immediate impact on divorced individuals who reside in any of the states where the ruling applies -- which includes Arkansas, Iowa, Minnesota, North Dakota, South Dakota, Missouri and Nebraska. However, the ruling also means that attorneys and financial advisors in other states should be aware that similar rulings in the future could be handed down in other states.
There are still ways that divorced individuals can seek to protect funds that are earmarked for their retirement. Keeping monies received as part of the divorce settlement separate from one's own retirement contributions is a start. Irrevocable trusts can also be used to shield funds from creditors.
Issues like this show the importance of working with good financial advisors in addition to your family lawyer during your divorce to make sure that you get the most up-to-date advice available.