Question: Will I lose my social security benefits in my Chapter 7 bankruptcy proceeding? Answer: No; except, of course, when the answer is yes.
The Social Security Act provides that no monies paid or payable under the act shall be subject to any bankruptcy law. 42 U.S.C. § 407(a). Therefore, your social security payments should be free from your bankruptcy estate under Chapter 7. But wait!
Problems can arise when you commingle your social security payments with unprotected funds. For example, lots of people deposit all of their funds initially into one account, whether it be a paycheck (which would be a part of the bankruptcy estate) or a social security payment (which would not). Under this typical scenario, which dollars on deposit in this account will the bankruptcy trustee treat as protected social security payments?
Virginia courts have adopted the very popular approach of a first-in/first-out accounting method. See, e.g., NCNB Fin. Services v. Shumate, 829 F.Supp. 178 (W.D. Virginia 1993). This is how it works . . .
Consider a scenario in which you first deposit a $1,000.00 social security check into your lone checking account and then later deposit a $1,000.00 paycheck into that same checking account. If you thereafter spend $1,200.00, how much of your social security payments remain in the checking account for bankruptcy purposes? The bankruptcy trustee will say that you have no social security funds on deposit because the first $1,000’s worth of purchases (i.e., the “first-out”) came from your earlier deposited social security check (i.e., the “first-in”). You would have only spent $200.00 out of your paycheck funds under this scenario. So what happens if you switch this scenario so that you deposit your paycheck first and your social security check afterward? How much of your social security payments remain in the checking account for bankruptcy purposes? Well, the bankruptcy trustee will say that you have $800.00 remaining in bankruptcy exempt social security funds (i.e., the entirety of funds remaining on deposit in your lone checking account) because, again, the first $1,000’s worth of purchases (i.e., the “first-out”) came from the earlier deposited paycheck (i.e., the “first-in”). You would have only spent $200.00 out of your social security funds under this scenario and you would have $800.00 left on deposit free from the bankruptcy estate.
This all serves to illustrate the obvious: the bankruptcy process demands professional planning. We here at Solan | Alzamora suggest that you open a separate bank account for the deposit of your social security payments, and that you draw from that account only after you have exhausted your regular funds on deposit elsewhere. Otherwise, you run the risk of losing your social security benefits to the bankruptcy estate through the otherwise avoidable commingling of funds.