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Bankruptcy Exemptions Force Sound Financial Planning

If you are considering filing for bankruptcy but are worried about losing your assets, think about your future. You may be surprised to know that Congress already has. State and Federal legislators have created types and amounts of property that you can keep after bankruptcy called exemptions. These exemptions can be substantial, enabling you to keep significant assets after bankruptcy. They are also a good roadmap for sound financial planning.
Those most reluctant to file for bankruptcy are those with assets which are not exempt, meaning their creditors would get them in bankruptcy. For some, the value of their home is more than $60,000 above what they owe on that home. That is, they have more than $60,000 equity in their home. For others, they have more than $5,000 equity in their car. Whatever the case, bankruptcy is not a good option for these people unless they engage in pre-bankruptcy planning, a process by which debtors sell property which is not exempt and put the proceeds into property which is exempt.

This process is legal, subject to certain guidelines, but should definitely be undertaken with advice from an attorney.

Because many people don’t want to sell their car or reduce the equity in their home, they often do not file for bankruptcy. The irony of this situation is that these reluctant debtors are often the ones with the greatest amount of debt. They have the most to gain by filing for bankruptcy, but ONLY if they are willing to engage in pre-bankruptcy planning.

To be clear, some of these people can pay their bills and they should. But, if you’re like many Americans, this is simply not realistic. While you may have some assets, you may have also recently lost a job; or the business you started may no longer be generating enough cash to pay the bills; or you’re getting on in years and wondering if you’ll ever get out of debt, let alone save for retirement. If this is your situation, bankruptcy is an opportunity for you, but it requires pre-bankruptcy planning.

The upside of pre-bankruptcy planning is often two-fold. First, it enables you to retain the value of your assets after bankruptcy, while your debts are wiped out. Second, because of the financial wisdom of most State legislatures (that’s right, I’m going to give them some credit), this process will force you to be smart with your money. Why? Because the exemptions are generally small for assets which lose value over time and large for those assets which gain value over time.

Cars are a perfect example. People often feel good about themselves for owning their vehicle free and clear. Certainly, there is a reason for this – you don’t have to make monthly car payments. But, don’t kid yourself, the value of your vehicle is only going one direction – straight down. In Colorado (where I practice), you are allowed to keep $5,000 of equity in your vehicle after bankruptcy. This fairly small exemption prevents debtors from having too much of their money in a depreciating asset after bankruptcy.

Note – this doesn’t mean your car has to be worth $5,000 or less, it just means the value of your vehicle minus the amount you owe on it has to be less than $5,000.

On the flip side, your home is often an appreciating asset (current times excluded of course) and, in Colorado, you get to keep $60,000 equity in your home through bankruptcy. So the Colorado bankruptcy laws allow and even encourage people to keep up to $60,000 in their home after bankruptcy. For example, if you have a $15,000 car with no debt on it and the equity in your home is $30,000, a pre-bankruptcy plan in Colorado may lead you to sell your car and replace it with a $5,000 car, and pay down your mortgage with the extra $10,000. While you may not like this, this move will help wipe out your debts in bankruptcy while also better positioning your assets for your future because that extra $10,000 of equity in your home will appreciate over time, while that same amount in your vehicle would only decrease.

If you already have $60,000 or more of equity in your home, there are other exemptions which also make long-term sense. My favorite exemption of all is retirement accounts. In Colorado, you get to keep whatever value you have in a retirement account, including IRAs and 401ks, after bankruptcy. For many, especially younger debtors, this may sound burdensome because you have to pay significant taxes in order to get to this money before retirement. However, is it really that bad to have a lot of money in a retirement account? OF COURSE NOT! Furthermore, if you really need the cash, you can borrow against these accounts, even with a bankruptcy on your record. After all, it is your money, AND THAT’S THE POINT.

If you’ve fallen on hard times but still own some assets, bankruptcy is an opportunity to engage in some financial planning which will improve your financial situation by not only wiping out your debt but also getting your property into sound investments which will increase in value over time. Sell the car(s), get into something with lower monthly payments, and boost your retirement accounts. While you may not like it now, your future will hold tens of thousands of dollars, if not hundreds of thousands, more for you!!