Creditor Protection for IRAs
By Jeremy Rodriguez, JD
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One of the greatest benefits offered under ERISA are the anti-alienation provisions, which provide that benefits under a pension plan cannot be assigned or alienated. While there are some statutory exceptions, ERISA essentially prevents retirement assets from being joined in any legal process to collect a commercial debt. These actions include garnishment, attachments, and other similar legal devices. There are some exceptions to this rule, the most obvious being divorce or legal separation.
But what about IRAs; what kind of protection do they enjoy under Federal or State law? Under Federal law, the only protection IRAs have is limited protection in bankruptcy proceedings. Currently, the limit under Federal bankruptcy law is $1,283,025 as of 4/1/2016. That limit is scheduled to be adjusted for inflation on April 1, 2019. It’s important to point out that bankruptcy proceedings also offer additional protection that is not available in other collection actions. In bankruptcy, amounts held in a qualified employer plan are excluded from the bankruptcy estate and are not subject to the dollar limit mentioned above. Even more, if those monies are rolled into an IRA, they keep the exemption and are not subject to the maximum cap for IRAs.
However, inherited IRAs aren’t offered the same protection. In Clark v Rameker, the Supreme Court held that funds in an inherited IRA are not exempt from the bankruptcy estate. The Court focused on the fact that the holder of an inherited IRA cannot invest additional monies into the account, must begin taking distributions regardless of age, and can withdraw the money at any time without penalty.
On the other hand, the protection is much different outside of bankruptcy. For example, what happens if you (or your dependents) get into a car accident or cause some other damage and have a large judgment against you? First off, the ERISA protection for assets in a qualified plan would still apply. That means any money in a company retirement plan would be safe from collection. However, unlike bankruptcy proceedings, that protection is lost once the monies are distributed out of the plan. This includes rollovers to IRAs. Instead of Federal law, people in this situation will look at State law to determine whether assets in an IRA are protected from general creditors. Thankfully, most states do offer some form of creditor protection for IRA assets. However, the amount of the exemption varies considerably. For example, some states limit the protection to only those amounts necessary for the support of the debtor and any dependents. Additionally, some states do not include SEP and SIMPLE IRAs in the protection statutes and others have special rules for Roth IRAs.
Finally, the rules are much different if the debt is an IRS levy. This shouldn’t come as a shock to anyone but the rules are much more favorable to the government when you owe them money. Not only is an IRA subject to an IRS levy, so are monies held in a qualified employer plan! If either of the accounts is levied, distributions are taxable to you. The IRS has indicated that it will go after other accounts first before issuing a levy on an IRA or qualified plan. Further, the tax code does waive the 10% early distribution penalty if the account is levied by IRS before you reach age 59 ½.
In sum, your IRA is one of your most important assets and will play a vital role in retirement. As those popular insurance commercials say, “Mayhem is everywhere,” and in most states, your liability could include “mayhem” caused by children or dependents. As a result, it’s important to work with a tax professional to understand how much of your retirement assets are at risk in general creditor proceedings.