Most Americans count on their retirement savings being there when they need them. But bankruptcy or an adverse judgment in a lawsuit could threaten your retirement security. That’s why it’s important to know which types of retirement accounts generally offer protection from creditors — and which ones are vulnerable.
Qualified plans are generally safe
Most qualified plans — such as pension, profit-sharing and 401(k) plans — are protected against creditors’ claims, both in and out of bankruptcy, by the Employee Retirement Income Security Act (ERISA). This protection also extends to 403(b) and 457 plans.
IRA-based employer plans, such as Simplified Employee Pension (SEP) plans and Savings Incentive Match Plans for Employees (SIMPLE) IRAs, are protected in bankruptcy. But they’re not necessarily protected outside of bankruptcy.
IRAs offer partial security
The level of asset protection available for your IRA depends in part on whether you’re involved in bankruptcy proceedings. In a bankruptcy context, creditor protection is governed by federal law. Under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, both traditional and Roth IRAs are exempt from creditors’ claims up to an inflation-adjusted $1 million.
The IRA limit doesn’t, however, apply to amounts rolled over from a qualified plan or a 403(b) or 457 plan — or to any earnings on those amounts. Suppose, for example, that you have $4 million invested in a 401(k) plan. If you roll it over into an IRA, the entire $4 million, plus all future earnings, will generally continue to be exempt from creditors’ claims in bankruptcy.
To ensure that rollover amounts are fully protected, it’s a good idea to keep those funds in separate IRAs rather than commingling them with any contributory IRAs you might own. Also, make sure the rollover is fully documented and the word “rollover” is part of its name. Further bear in mind that, once a distribution is made from the IRA, the distributed funds are no longer protected.
Outside bankruptcy, the protection afforded an IRA depends on state law. Most states provide traditional and Roth IRAs with some protection against creditors’ claims. It’s uncertain whether SEP plans or SIMPLE IRAs are protected outside of bankruptcy, but there’s some precedent for the argument that state-law exemptions don’t apply to these IRAs.
Nothing is certain
Note that even employer plans and IRA assets aren’t protected in some circumstances. For example, the IRS can seize distributions from retirement accounts for unpaid taxes. And under a Qualified Domestic Relations Order, an ex-spouse may have access to retirement benefits. Because your situation is unique, give us a call to talk about the best way to protect your retirement assets.
Sidebar: A question of inheritance
A recent Supreme Court case, Clark v. Rameker, clarified what had been unsettled: Bankruptcy protection does not extend to inherited IRAs. In a nonbankruptcy context, some states expressly exempt inherited IRAs, while courts in other states are divided on the issue.
To provide additional asset protection to your heirs, consider naming an IRA trust as beneficiary of your IRA. A well-designed trust will preserve the tax-deferral and other benefits of the account while offering greater asset protection to your beneficiaries than an inherited IRA.