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Protecting bank account funds is a priority for most people filing for Chapter 7 or 13 bankruptcy. How bankruptcy will affect your cash or bank account deposits depends on whether the money is protected by a bankruptcy exemption and whether you are able to do some pre-bankruptcy planning to protect money that is not exempt in bankruptcy.

Is the Money in Your Bank Accounts Exempt?

In bankruptcy, some of your property is “exempt,” which means it does not become part of your bankruptcy estate. In Chapter 7 bankruptcy, the trustee cannot take exempt property, which means you get to keep it. In Chapter 13, your property is safe, but you must pay back the amount of your nonexempt property during the life of your repayment  plan.

If the funds in your bank account are covered by an exemption, you don’t have to worry about losing the money or having to pay it back through your Chapter 13 plan.

If part of your cash or bank account deposits is not covered by an exemption, you may still be able to protect some or all of these funds by some careful pre-bankruptcy planning.

Pre-Bankruptcy Planning to Convert Nonexempt Bank Account Funds into Exempt Assets

Pre-bankruptcy planning, also called asset conversion, is the legal method of reorganizing assets in order to protect as much property as possible from creditors. In the context of bank accounts, this would amount to using funds over the exemption amount to purchase or invest in exempt assets.

Is it Legal?

While bankruptcy law allows you to convert nonexempt property into exempt property if you are acting in “good faith,” it does not allow you to attempt to hinder, delay, or defraud creditors. You should tread very carefully if you want to convert bank account funds to exempt property.  Here’s why:

• Determining whether a debtor’s prebankruptcy asset conversion is in good faith or not can be tricky.
• While the majority of courts recognize that debtors are allowed to convert nonexempt property into exempt property in order to take advantage of exemption laws, a minority of courts denounce pre-bankruptcy planning as fraud.

Proceed Carefully

When converting cash or bank accounts to other property before bankruptcy, avoid overly aggressive tactics. When in doubt, consult with an experienced bankruptcy attorney. Local attorneys often have a good sense as to what your local court will consider to be legitimate pre-bankruptcy planning tactics and what will get you into trouble.

Forms of Allowable Pre-Bankruptcy Planning

Most courts recognize that, absent fraudulent intent on the part of the debtor, asset conversion is allowed in order to make full use of statutory exemptions, even if done on the eve of bankruptcy. Courts will generally allow you to use nonexempt portions of your bank account funds in order to:

• Pay down your mortgage in those states with significantly large homestead exemptions.
• Make an annual contribution to your retirement account, IRA, or other exempt pension plan, as defined by your state’s exemption list.
• Purchase exempt personal property, such as cars, household goods, furniture, clothes or other essential items. Remember, the exact exemption amounts for each of these items varies from state to state.
• Purchase a life insurance policy.
• Pay down your nondischargeable debts such as taxes, student loans, alimony, and/or child support. 

Forms of Asset Conversion That Are Not Allowed

If the bankruptcy court believes you intended to defraud creditors with your asset conversion, it may impose civil or criminal penalties.

In deciding if you intended to defraud creditors, courts look at a number of factors, including whether:

• you misrepresented asset values
• the property or investment was worth less than the funds you spent
• your family or other people with whom you have a close relationship were involved in the property purchase, and
• your lifestyle changed radically.

If you are considering what to do with your non-exempt bank account funds, keep these tips in mind:

• Do not give away or hide money or simply transfer it to another’s name.
• Pay fair market value for any purchases and engage only in legitimate transactions.
• Do not pay debts to relatives or friends prior to filing because it would constitute a “preferential transfer” and the trustee will sue your relative or friend to retrieve the money.
• You will have to disclose all asset transfers “outside of the ordinary course of business” within 90 days before filing of the bankruptcy petition or within one year to a friend or relative, otherwise known as an insider. 

Additional Measures to Protect Your Bank Accounts: Avoiding Set-Offs and Freezes

If you owe your bank or credit union any money at the time of filing for bankruptcy (such as past due fees) or if your bank or credit union has extended credit to you (such as a loan, mortgage, or credit card), that institution has the right to “set off” the debts owed to it against any bank account funds you may have with them. Banks and credit unions have the right to set-off your accounts at any time, regardless of whether or not you file for bankruptcy.

Although banks rarely exercise their set-off rights, it makes sense to take precautions before filing for bankruptcy. The best way to avoid a set-off is to withdraw the funds from any account held with a bank or credit union to which you owe a debt.

It’s also possible that your bank will “freeze” your accounts once you file for bankruptcy. Several banks, notably Wells Fargo and Union Bank, have done this to preserve account the funds until the bankruptcy trustee decides what to do with them. Although a judge will eventually “unfreeze” the accounts, it could take several weeks. Again, the best precaution is to withdraw funds from a Wells Fargo or Union Bank account prior to bankruptcy or transfer the funds to a different bank.