Prepare for Federal Bankruptcy Law Change

Physician's Money DigestOctober 2005
Volume 12
Issue 14

This month, the decision to file bankruptcywill become even more difficult. The BankruptcyAbuse Prevention and ConsumerProtection Act of 2005 goes into effect October 17with significantly tougher reporting and qualificationrequirements. The most highly publicized aspect ofthe new law involves tough new restrictions on whoqualifies for Chapter 7 bankruptcy, the most commonform of individual filing.

Advisors say it's important to understand oneimportant fact: Your own state laws might overridesome of the new federal restrictions, making the paymentand asset-retention outlook better or worse thanit would be strictly under federal law. That's why it'scritical that potential filers obtain the advice of a qualifiedlocal bankruptcy attorney, Certified FinancialPlanner™practitioner, or tax professional—or all three.

The following are some basic questions aboutbankruptcy and the effects of the new law:

What are the most important changes? Newfederal requirements for Chapter 7 now impose anincome test (ie, a means test) that allows exclusionfor certain living expenses, including the following:

  • If average monthly net income for 60 months isgreater than $10,000, filing is not permitted.
  • If average monthly net income for 60 months isless than $6000, filing will likely be permitted;
  • Between $6000 and $10,000, filing is allowedonly if net monthly income is less than 25% of allnonpriority unsecured debts.

After October 17, filers will also have to complete6 months of consumer credit counseling, preferablywith a debt payment plan, within 6 months of filing.Detailed reporting requirements will also disclose ifyou were acting irresponsibly with credit cards previousto filing.

Will documentation change? Under the oldcurrent Chapter 7 requirements, filers needed to basicallylist current assets, debts, income, expenses, andan overall statement of financial affairs. Under thenew law, courts review tax returns and detailed projectionsof earnings. They'll also evaluate assets inretirement accounts and even education accountssuch as 529 savings plans.

What about home-ownership issues? If youmove to a new state, you have to live at that domicilefor 730 days. Regardless of what state laws apply, thenew bankruptcy act maintains that you must live ina home for 1215 days (40 months) to receive yourstate's homestead exemption. Otherwise, protectionfor the home is capped at $125,000. Also, there's a10-year review period to determine if a filer attemptedto transfer money or equity into a homestead withthe intent to hinder, delay, or defraud a creditor.

What about retirement assets? For filings onor after October 17, retirement funds that areexempt from taxation, including qualified plans,qualified annuities, or deferred compensationplans, will likely remain exempt. However, funds ina traditional IRA or Roth IRA—but not simplifiedemployee pension plans or SIMPLE IRAs—areexempt only up to $1 million. Again, check yourstate law for exact rules.

What about education savings? All moneyheld in a Coverdell Education Savings Account ora 529 savings plan for more than 2 years is protectedfrom payment of bankruptcy debts as long asthe account beneficiary is a child, stepchild, grandchild,or stepgrandchild.

Where can a consumer find advisors? Oneresource for certified bankruptcy attorneys is theAmerican Board of Certification (, which provides a state-by-state listing. TheNational Foundation for Credit Counseling ( lists nonprofit consumer credit counselingagencies nationwide. Advisors can also belocated through the Financial Planning Association® ( Be sure to checkall references locally.


It's unclear if consumers could have avoided thishassle by filing before October 17. If necessary, aknowledgeable investment advisor can guide youthrough the new bankruptcy law. There is no one-size-fits-all bankruptcy solution.

Reprinted with permission from the Financial Planning Association (www.fpa,

the membership organization for the financial planning community.

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