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Creditor Protection for Retirement Plan Assets

In this day and age with bankruptcies on the rise, quite often this question comes up:  are my retirement plan assets protected from creditors? And of course, there are two ways you can take this – are the assets protected from creditors of my employer; and are the assets protected from my personal creditors?

protection-by-hryck

Employer Creditors

Your qualified retirement plans (401(k), 403(b), etc.) are always protected from creditors, in the event that your company should declare bankruptcy.  The same is true for traditional qualified pension plans.  However, with certain nonqualified retirement plans, there is a strong possibility that these assets could be accessed by your employer’s creditors in the event of a bankruptcy.

These plans are often called executive compensation, rabbi trust, deferred compensation, or supplemental retirement savings (among many other terms).  The key here is that these accounts are “non-qualified”, and as such are not protected by the ERISA law.  These accounts are very often open to access by creditors, so be aware of this if you’re a participant in such an account.  Check with your HR department if you’re unsure if your retirement account(s) are qualified (and thus protected by ERISA) or not.

IRAs, being individual accounts totally separate from your employer (unless you’re self-employed) are not considered in any way the assets of your employer.  If you are self-employed and are not incorporated in some fashion, depending upon your state law, some of your IRA assets could be at risk, depending upon the state that you live in, and the balance of the account (see below).

Personal Creditors

In general, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) provides that both traditional and Roth IRAs derived from contributions are protected from creditors up to $1 million.  This protection only applies to bankruptcy, not to other judgments, and as such state law applies for all other situations.  The level of creditor protection varies widely by state.  For more up-to-date information on the protection within your state, click this link.  Rollover (including, if you’ve been paying attention, trustee-to-trustee transfer) amounts from employer plans, SEP or SIMPLE IRAs have unlimited protection from creditors.

There are cases, as illustrated recently in a case that was decided in 2007, where an inherited IRA with a revocable trust as the beneficiary became available to the decedent’s creditors.  This case was in the state of Kansas, so other states may have differing laws, this was just an example.  The way to resolve or avoid this is to use an irrevocable trust as the beneficiary and use discretionary and spendthrift clauses within the trust as protection.  Otherwise, naming an individual (or individuals) as the IRA beneficiary(s) would avoid this problem as well.

Further problems develop in the inherited IRA spectrum due to the fact that most state courts do not consider an inherited IRA to be a “retirement account”, since the owner (the beneficiary of the decedent) is currently receiving an income from the account.  This is important because retirement accounts are specifically protected from creditors (due to BAPCPA).

Closing

So, even though the IRA has somewhat fewer protections against creditors versus the employer plans, if you’ve left the employer this shouldn’t be the reason to leave funds in the old account.  An IRA account can be considerably more flexible, easier to access, and (likely) lower in cost overall.  If protection against creditors is a great concern, umbrella liability and/or malpractice insurance could be used as a low-cost alternative.

Photo by Hryck.

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