Financial crises can sometimes strike quickly and unexpectedly. In fact, a recent study by Harvard Law and Medical Schools found that almost half of those who file for bankruptcy protection do so because of medical expenses. Others may find themselves reeling from lawsuits or filing personal bankruptcy because of business losses. Each of these reasons – and several others – are certainly legitimate, albeit unfortunate, reasons to file for bankruptcy.

However, abuses of the system have been on the rise. Congress and the President have recently stepped in with reform. At the heart of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 are standards for bankruptcy judges to determine whether a filing is reasonable or the applicant is taking advantage of the system. Changes are meant to direct higher-income debtors away from Chapter 7 proceedings – which wipe a person’s financial slate clean – to Chapter 13 bankruptcy, which involves agreeing to repayment plans with creditors.

The law also:

• Protects up to $1 million in Individual Retirement Accounts (IRAs). This does not apply to amounts rolled over to an IRA from a “qualified” plan or to the earnings on the rollover. Those funds are still protected without a dollar limitation.
• Safeguards education savings. Funds in Coverdell Education Savings Accounts and 529 Plans are generally unavailable to bankruptcy creditors. However, in order to be protected, accounts must benefit children or grandchildren. Also, any deposits made within the past year are available to creditors, as are any deposits made the prior year amount above $5,000.
• Sets a $125,000 limit on state exemptions for homes. If a home is purchased within 40 months of filing bankruptcy, the owners’ ability to exempt the full value of their home is limited to just $125,000. If a person sold one home and bought another in the same state within the last 40 months, rolling equity from the first home is protected.
• Expands paperwork requirements to file for bankruptcy. Filers were formerly required to include only a list of debts, recent tax returns, deeds and titles to real estate and automobiles, and documents for other outstanding loans. Now, an individual must also file a certificate of completion of a personal financial management class, recent pay stubs, a monthly income statement, an annual statement of income and expenses (for a Chapter 13 filing), notification of increases in income or expenses and notices to creditors of bankruptcy filing.