California Bankruptcy Exemptions Under Chapter 7: A Primer
The Chapter 7 bankruptcy process is a fairly straightforward process: you declare your assets and debts and the Chapter 7 trustee liquidates your assets to pay off your creditors. To put it this simply, one may be excused for thinking: "Oh no! Does that mean I will lose my car/house/clothing? How will I do anything?"
No, it does not. Leaving you without the ability to get around or a roof over your head will be a cruel ending to a bankruptcy discharge. Bankruptcy, after all, is supposed to give you a fresh start on life with no or drastically lower debt, not leave you completely unable to do anything. As such, the bankruptcy process allows the petitioner to exempt assets that are otherwise subject to the bankruptcy process; in the case of a Chapter 7 liquidation, this means exempting assets from a trustee liquidation sale. The Bankruptcy Code allows individual states to set statutory exemptions (as a "fresh start" may mean different things in California than, say, in Mississippi). California, in fact, has two systems of exemptions; each has its advantages and disadvantages. SYSTEM ONE The biggest advantage to the first system is that it allows a $50,000 to $125,000 homestead exemption, depending on your circumstances. This may not sound like a lot (and it is not in many places in California) and you may think that such a low exemption may allow the trustee to sell your house. However, if your house is subject to liens (mortgage, home equity loan, etc.) and the total lien obligation plus your exemption amount is less than the value of your house, then the trustee most likely will not sell your house because s/he will not gain anything from the sale (remember, trustees are looking to make a profit from liquidation sales). In fact, if the value of your house is within a nominal amount -- say $10,000 -- of the lien plus exemption amount, the trustee still will not sell the house since s/he will have to deal with fees, taxes, etc., from the house sale. As an aside, if your house is fully-paid for and not subject to any liens, then Chapter 7 is NOT for you; your house will most likely get sold by the trustee (unless it falls within the exemption amount). If you must enter the bankruptcy process, Chapter 13 is a better option. Other options include a home equity loan to pay off your current creditors (one home equity loan will probably have better repayment terms than five or six separate credit card bills) or selling your current house, moving into more affordable housing and using the proceeds from the sale to pay off your debts (this is similar to what the trustee will do but your credit will stay intact).
Another advantage to the first system is that it exempts the total value of many pension plans, including those of county and public employees and private IRA and Keogh plans. As non-excludable pension plans are also assets that may be liquidated by a trustee to pay off your creditors, if you have high-value retirement accounts that are not otherwise excluded by the Bankruptcy Code from your bankruptcy estate (see below), the first system is probably for you.
A big disadvantage to the first system is that its exemptions for some personal property are relatively low. For example, you may only exempt $1900 for your automobile so pretty much any paid-for car could be subject to a liquidation sale. On the other hand, it allows a rather high exemption ($5000) for "jewelry, art and heirlooms".
Another disadvantage is that -- other than very narrow exemptions -- there is no way to protect your bank accounts or investments from liquidation under the first system.
The second system of exemptions in California is perfect if you have no equity in your house (or do not own a home) and possess personal property that is moderately valuable.
While the homestead exemption in the second system is only $17,425, if you don't have a house, you can use that amount towards ANY asset. Further, there is also another $925 "wild card" exemption you can use towards any asset for a total of $18,350 of exemption value towards any of your property. Finally, the specific property exemptions are more favorable under System Two, including a $2,775 car exemption and a $450 per item exemption for a wide range of personal property; you can supplement these amounts with the homestead exemption. For example, if you have a paid-for car that is worth $6,000, you can completely exempt it using all $2,775 of the car exemption and $3,225 from the homestead exemption.
You can also use unused homestead and "wild card" exemption amounts to protect checking, investment and savings accounts.
Though pensions and other retirement accounts are seemingly not fully-covered by either system of exemptions (indeed, System Two only covers ERISA-qualified plans), your retirement account will nonetheless most probably be safe from a bankruptcy trustee seizure and liquidation.
One of the very few good things included in the 2005 bankruptcy reforms was a general exclusion from a Chapter 7 debtor's bankruptcy estate of all pensions that are considered tax-free by the IRS. If your pension, deferred compensation account or any other kind of retirement account falls under Internal Revenue Code sections 401, 402, 403, 408 or 408A, it will NOT be part of your bankruptcy estate; it cannot be seized or liquidated to pay off your creditors. Odds are, your retirement account qualifies under these Internal Revenue Code sections; if you have any doubts, it is extremely easy to find out, as well (just ask your HR representative at work or your accountant).
If by some chance your retirement account is not tax-free, then you should consider System One.
FEDERAL SUPPLEMENTAL EXEMPTIONS
In addition to the California statutory exemptions, petitioners in California may also take advantage of federal supplemental exemptions. These exemptions include federal employees' pensions, Social Security benefits, 75% of earned but unpaid wages and some other narrow categories.
To take full advantage of the exemptions may take some planning before you file for Chapter 7, especially if you have, say, an expensive paid-for car and/or a house. You will need to make some choices on which assets you will want to keep and which ones you will want to abandon to the trustee or trade-in for something less expensive. If you have a lot of assets you cannot allow to be liquidated and you cannot exempt, then it is better to file a Chapter 13 petition, especially if you have a steady income. Talking to a bankruptcy attorney about your options with California's bankruptcy exemptions is desired.