Your Checking and Savings Accounts in Chapter 13 Bankruptcy (2024)

Debtors filing for Chapter 13 bankruptcy should plan for potential problems with checking and savings accounts similar to the banking issues experienced by Chapter 7 filers. Chapter 13 filers must protect the funds in accounts with bankruptcy exemptions and pay creditors an equivalent to any funds they can't protect through the Chapter 13 plan (or turn the nonexempt funds over to the trustee).

Chapter 13 filers also must deal with the bank withdrawing funds to repay debts owed to the bank and the possibility of temporarily freezing the account. Learn more about protecting bank accounts in bankruptcy.

Bank Accounts and Other Property in Chapter 13

Chapter 7 and Chapter 13 filers can protect or "exempt" the same amount of assets in bankruptcy. They use the same group of bankruptcy exemptions—the laws outlining the property bankruptcy filers can keep from creditors. But that's where the similarities end. What happens to "nonexempt" property—assets not covered by an exemption—differs in Chapters 7 and 13.

In Chapter 7, the trustee appointed to the case sells nonexempt property and distributes the proceeds to creditors. Chapter 13 trustees don't sell property. Instead, Chapter 13 filers must pay to keep nonexempt property—and under the "best interest of creditors" rule, it must be at least as much as creditors would have received in Chapter 7.

Example. When Herman was considering bankruptcy, he learned that his prized art piece—a large, heavy sculpture he purchased in Italy—wasn't protected by a bankruptcy exemption. The appraised value was $7,500. If Herman filed for Chapter 7, the trustee would sell the sculpture, and creditors would share $5,000 after the auction and shipping fees. However, Herman wanted to keep it, so he filed for Chapter 13 and paid creditors $5,000, the amount creditors would have received in Chapter 7, through the Chapter 13 plan.

Protecting Checking and Savings Account Balances

Almost every state has a set of bankruptcy exemptions. Although each state's set is unique, most states offer little regarding exemption protection for cash or funds in bank accounts.

Sometimes, filers use a "wildcard" exemption, allowing them to choose the property they'd like to protect. However, you'll want to read the exemption carefully. Some come with conditions, such as excluding cash or money in a bank account.

Using the federal bankruptcy exemptions might be advantageous if your state allows filers to use them instead of state exemptions. The federal wildcard exemption exceeds the amount available in many states.

A Chapter 13 filer typically keeps nonexempt property by paying its value through the Chapter 13 plan. A filer could propose to make payments covering funds in an account. However, the trustee or creditors might object and argue that the filer should turn over the funds immediately for creditor payments.

If paying money to keep money in an account sounds odd, it is somewhat. To put this into perspective, this situation doesn't arise often in Chapter 13. Most bankruptcy filers don't have much cash available when filing for bankruptcy. The funds are usually used long before the filing takes place in an attempt to avoid the bankruptcy filing.

The small amount of unprotected funds a filer might have soon before the Chapter 13 filing is often used beforehand for lawyers' fees and necessary items like rent, food, and needed clothing—which is perfectly acceptable.

Large Deposit Accounts in Chapter 13

When someone with a large amount of cash inquires about bankruptcy, they're usually looking for a way to keep cash assets while avoiding paying debt. But because bankruptcy doesn't protect people this way, they typically find they won't benefit from it.

Instead, most people in this situation typically do better negotiating down the debt balances with creditors outside of bankruptcy and paying creditors directly from the assets. The debtor can easily calculate how much they'd pay in bankruptcy and offer creditors less in exchange for a lump sum payment rather than one paid over five years. This approach saves, at a minimum, the trustee's fee, which can be up to 10% of the debts paid through the plan, but often more.

Other Banking Problems in Chapter 13

The other issues filers often face involve the bank closing an overdrawn account—which can be problematic because many banks won't open new accounts soon after a bankruptcy filing—unexpectedly losing funds to a bank set off, or losing access to money after the account is frozen.

The easiest way to avoid the problems is by opening a new account elsewhere before filing for bankruptcy and keeping the balance low. This strategy also helps prevent the problem of exempting bank account funds.

The Bank's "Set Off" Privilege

When a debtor owes money to the bank or credit union with which they hold an account, the bank or credit union has the right to "set off" the debts against the funds in any checking or savings account the debtor might have with them. For instance, members of credit unions frequently have personal loans, auto loans, mortgages, or credit cards with their credit unions.

If the bank opts to use the set off provision upon learning of the bankruptcy, the bankruptcy trustee might be able to recover the money, but the funds will likely be used to pay creditors. Most bankruptcy lawyers will advise you to take steps to avoid the situation rather than attempt to unwind it afterward.

The Bank's Decision to "Freeze" Your Account

Some banks routinely freeze the bank accounts of bankruptcy filers, claiming that the freeze protects potential bankruptcy assets. This situation can be resolved with a phone call from the trustee or, in unusual cases, a motion with the court. Although the trustee will usually call quickly, the process could take several weeks.

Some jurisdictions might prohibit this practice, and bank policies can change. Ask your local bankruptcy lawyer for guidance. Learn about closing bank accounts before bankruptcy to determine whether it's wise to get your cash out first.