Hands off my federal benefits!

By Blake Ellis, staff reporter

NEW YORK (CNNMoney) -- It just got a little harder for banks to seize money from accounts holding federal benefits like Social Security and disability checks.

A new rule issued by the Treasury Department and a group of other federal agencies takes effect Monday and aims to protect struggling retirees and others who depend on government payments from losing a crucial source of income.

The rule states that banks garnishing funds from consumers who receive federal benefits must leave at least two months worth of benefit payments in the account. That means Social Security, disability payments, Supplemental Security Income and the majority of other government payments are off limits -- at least in part.

Creditors have the right to garnish funds from individuals who have defaulted on debts like credit cards payments, utility payments, medical bills, alimony and any other loans -- if the creditor wins a judgment against the debtor.

But not all debtors are protected. If you owe money to the government, like taxes, your federal benefits are still fair game.

Before the rule went into effect, creditors were already prohibited from touching these funds, but they did have the option to obtain court orders letting them freeze or garnish accounts containing federal benefits.

It wasn't previously the creditor's responsibility to determine which funds in an account were federal benefits, said Margot Saunders, council at the National Consumer Law Center. Starting Monday, it will be.

Court orders often made it impossible for recipients to access their federal funds for weeks or months. And if they didn't take the time to request and fill out the paperwork needed to end the account freeze, the money would often be turned over to the creditor.

Illegal seizures on the rise

The National Consumer Law Center estimates that more than a million consumers are hit with illegal garnishments of federal benefits per year, and that the number has only risen in the past decade as banks have hiked fees and issued credit to consumers who can't pay.

"Banks have been making loans to people who don't have the ability to repay them," said Saunders. "Banks have then routinely been ignoring the letter of the law and seizing exempt benefits to turn over to creditors, thinking there's very little the consumer can do about it."

Now that the rule is in effect, creditors will have to identify which funds were deposited by the U.S. government within the last two months, and leave those benefits untouched, which should cut down on some of those illegal seizures.

Funds exceeding the two-month amount aren't covered by the new rule though, so for those recipients who save up, accumulated payments are still up for grabs and vulnerable to court-ordered freezes.

And because of another new rule, some federal benefit payments should now be easier for creditors to identify, said Saunders.

Also starting Monday, anyone applying for Social Security benefits is now required to receive payments by direct deposit, rather than by mail. People who are already receiving payments have until March 1, 2013 to make the switch.  To top of page

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