There's a surge in personal bankruptcy filings at the moment, for obvious reasons. Some 30,000 Americans are filing each week, and the figures could top 1.4 million for the year.
But too many people are talking about bankruptcy as if it's a sign this country's social safety net has failed.
It isn't. Bankruptcy is part of the safety net. Other countries have welfare states, America has bankruptcy. And so long as you plan ahead, it doesn't have to wipe you out.
If you are smart you could get through a bankruptcy filing and still keep your home, your retirement savings, the childrens' college funds, your car and your personal effects. Amazingly, according to a recent study by the Federal Reserve Bank of Boston, you may even get your credit cards back pretty soon -- whether that is a good thing is another matter.
I don't want to encourage irresponsible behavior. But I don't write the laws, and they are there for a reason.
Furthermore, although there is some dispute about the numbers (we'll get to that in a minute), it is certainly the case that sheer bad luck lands a lot of people in bankruptcy court. Yes, some people spend themselves into oblivion on Jacuzzis and trips to Lake Tahoe. But many others are walloped when their job is eliminated or when a child gets very sick.
Every middle class family should be aware of the risks of bankruptcy, and how to protect their assets if the sky falls.
Bankruptcy laws are complex and vary from state to state – if you want to make substantial plans you should probably talk with a lawyer in your state who specializes in the subject.
Some basics: Money in pension plans, including a 401(k), should be secure from creditors. The same is true for money in an IRA in amounts up to $1 million. If you have children or grandchildren, money in 529 tax-sheltered college savings plans becomes secure two years after deposit. You can contribute $65,000 per child to your 529 plan this year without triggering gift taxes, or $130,000 if you're a couple. You retain control of the money in the plan, too.
Life insurance products, including retirement annuities, may also be protected, though rules vary by state.
Many states have a homestead exemptions that shield your home from unsecured creditors (though your home's mortgage isn't shielded, of course). You usually have to file paperwork to obtain the exemption. Florida and Texas, famously, offer virtually unlimited homestead exemptions. "It's irresponsible not to have a homestead exemption on your house," says Frank Morrissey, who teaches bankruptcy law at Boston University.
Little known: In more than 20 states married couples can own their home as "tenants by the entirety," which affords substantial protection against a creditor of one spouse (though not of both). "In effect, neither party owns the property, it's owned by the marriage," explains Richard Nemeth, a bankruptcy lawyer in Cleveland.
There are other exemptions that vary by state, from a car and working tools to some other personal effects. Iowa exempts a family shotgun: An enterprising bankrupt several years ago bought a $10,000 antique gun on the eve of filing for bankruptcy to claim the exemption. He got away with it, too.
Such boldness is usually a bad move, however, as courts frown on naked greed. "When it comes to bankruptcy," says B.U.'s Mr. Morrissey, "the usual rule is, pigs get fat, but hogs get slaughtered." The earlier you shelter assets, the safer they should be.
As long the economy stays grim, bankruptcy filings will become increasingly common – which may diminish the stigma that accompanies bankruptcy. It is, in a sense, surprising that so many Americans should still feel ashamed of bankruptcy when those in a far more comfortable situation feel no such chagrin. Corporate bankruptcies are an accepted part of doing business from Wall Street to Silicon Valley. Executives who collect $30 million from a bank in the years before it collapses are not expected to give it back.
Bankruptcy gives people a fresh start, but the long-term effects vary. A study last year by researchers at the Federal Reserve Board in Washington, D.C., found that people who filed for bankruptcy were more likely than others to fall back into debt arrears, even many years later. But there may be complex reasons for that, and every case is different. (Here's a link to the study:http://www.federalreserve.gov/pubs/feds/2009/200917/200917pap.pdf)
As for the causes of bankruptcy: The widely reported statistic that nearly two-thirds of personal bankruptcies are caused by medical bills deserves a more skeptical eye. The number comes from a study by Dr. David Himmelstein, et. al, to be published next month in the American Journal of Medicine. Yet if you read the report you'll discover only 29% of those interviewed for the study actually said their medical bills caused their bankruptcy. And while the "medically bankrupt" claimed average medical bills of $17,943, that group's total net debt averaged $44,622, or more than twice as much.
Claire Ann Resop, a bankruptcy lawyer in Madison, Wisconsin, adds that medical debt may show up more in bankruptcy filings because it's often the last bill you pay when you get into trouble. Hospitals may be lenient on repayment and charge no interest, while the landlords demand cash and the credit card company charges 30% interest. "Medical facilities may simply be the best creditors to have," she says.
Write to Brett Arends at email@example.com