Investing During Chapter 13

Chapter 13 is called the wage earner's program or reorganization bankruptcy. You will come up with a strict budget for the next three to five years that's reviewed and approved by the bankruptcy trustee. Your disposable income, what's left over from your income after you subtract out allowable expenses, goes to pay your creditors. Contribution to a 401K retirement plan, or other plan, is at the discretion of the trustee and depends on how close you are to retirement and what's already been invested. That contribution decreases the amount paid to your creditors. When you've completed the payment program for the three to five years, the remaining amount of dischargeable debts are discharged.

Chapter 7 is a clean sweep. Your non-exempt assets will be sold and all proceeds paid out to your creditors. As soon as that's done your debts are discharged. Here's the catch, while you are allowed to keep your assets in a Chapter 13, in other words they won't be sold, the total paid out through the Chapter 13 to your creditors has to be at least what they would have gotten in a Chapter 7.

In a Chapter 13, if your salary changes, you win the lottery, you receive an inheritance, your significant other goes back to work or your expenses decrease, you must inform the court. You will need the court's permission before you can invest any excess money. You also need the court's permission to sell an asset and dispose of the proceeds. The court may order you to pay any proceeds to your creditors.

The federal bankruptcy laws define what assets you can keep and what can be sold. States have their own exemptions. For example, as of the time of publication, Arizona allows you to keep $150,000 of equity in your home, while Florida allows unlimited equity. Some investments are exempt, such as retirement plans -- 401K -- pensions and annuities. Others such as mutual funds, savings accounts and stocks are not. Again, it's determined state by state.

If you miss payments during the course of the Chapter 13, the court may convert it to a Chapter 7, without your approval. If you don't report increases in income or assets, and the court convicts you of bankruptcy fraud you may have to pay fines of up to $250,000 plus up as much as five years in federal prison.