En español | Q. I filed for Chapter 13 bankruptcy after being laid off. Do Social Security benefits count as income in bankruptcy, or are they protected?
A. Federal law says your benefits are protected. On several occasions, Congress has made it clear that Social Security benefits are excluded from the financial assets that are used to repay creditors in a bankruptcy case.
See also: Avoiding bankruptcy.
Meanwhile, the Social Security Administration (SSA) says it will not honor court orders to hand over anyone's Social Security benefits to a bankruptcy trustee.
"It seems clear that Congress fully intended to leave Social Security income off the table, as a core policy decision," Missouri bankruptcy attorney Wendell Sherk wrote in an article on the Bankruptcy Law Network website.
In an interview, Sherk said that Congress spoke on the issue in the 1935 legislation that created Social Security, again in the sweeping 1983 amendments to Social Security and most recently in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.
Packing the repayment plan
The 2005 act, Sherk said, made it more difficult for individuals to declare bankruptcy. But the act also reinforced long-standing congressional rules protecting Social Security benefits.
Yet there are Chapter 13 bankruptcy cases in which Social Security benefits are included in repayment plans.
Sherk suggests that bankruptcy trustees, who represent creditors, may try to pack as many assets as possible into a repayment plan. If the debtor doesn't challenge it, the benefits may remain in the repayment plan.
It's unclear how often Social Security is included, but it's often enough that courts have been asked to rule on the legality of the practice. In two separate cases recently, the U.S. Court of Appeals for the 8th Circuit and one of its appellate panels ruled that Social Security benefits were off limits in bankruptcy cases.
Recent court decision
In the case before the 8th Circuit Bankruptcy Appellate Panel (PDF), an older Missouri couple who had filed for Chapter 13 bankruptcy devoted $1,155 a month to their repayment plan. But they had more than $2,560 a month available. The extra funds were from Social Security.
The law has always allowed a debtor to voluntarily use Social Security payments to fund a repayment plan, but the trustee claimed that failing to apply these extra funds to the plan meant the couple had not proposed their plan in good faith.
The appellate panel disagreed. In a ruling last summer, the judges pointed out that Congress had excluded Social Security from consideration as disposable income, so it was not bad faith for the couple to do what Congress said they could do.
The 8th Circuit Court of Appeals covers seven Midwestern states. The decision applies only to those states but can carry weight with courts outside the circuit.
Sherk says that the trend in the field of bankruptcy is toward the belief that "your Social Security benefits should go directly from the SSA to the grocery store."
But if the trustee handling your repayment plan thinks otherwise and wants to include your Social Security benefits, it may be up to you to speak up — and there will be a lot of law on your side.
Stan Hinden, a former columnist for the Washington Post, wrote How to Retire Happy: The 12 Most Important Decisions You Must Make Before You Retire. Have a question? Check out the AARP Social Security Question and Answer Tool.