Our retirement assets are down but should not be forgotten. Depleted or not, there are plenty of folks out there who would like to have them. That includes creditors. So what kind of protection is available for retirement accounts from the claims of creditors?
Judgment Creditors and Retirement Accounts
The first issue that comes to mind is protection of retirement assets of one spouse from the creditors of the other spouse. This will depend in large part on how the asset is owned. 401(k) and IRA accounts are not jointly owned but they do have beneficiaries. Generally, a creditor of a non-owner spouse has no rights to pursue that asset except if the owner spouse dies while the account is still in place. Then it gets more complicated.
Federal and State Protection of Retirement Assets
Funds held in 401(k) plans are shielded from all creditors by the federal Employee Retirement Income Security Act (ERISA). No federal or state court creditor can touch 401(k) money except for claims made by a spouse or by the IRS.
Funds held in an IRA are not protected by ERISA. However, the 2005 bankruptcy reform legislation provides protection for up to $1 million in IRA funds that you contributed, including Roth IRAs. This makes it even more important to keep good records of your IRA contributions.
SEP, Simple IRAs, Keogh, and solo 401(k) plans are completely exempt (with no upper limit) from bankruptcy proceedings, as are IRAs that are rolled over from a 401(k) or other qualified retirement plan.
Outside of federal protection, the ability of creditors to go after IRA funds in or outside of bankruptcy is determined by state law. Some states (New York, New Jersey and Connecticut for example) will protect all IRA funds while other states will cap that protection at $100k or $500k.
Still other states – California being a prominent example – protect only those IRA and other retirement assets that are “reasonably necessary” to support the owner of the funds and dependents. This is a flexible test that depends on the owner’s income, age, and other assets.
Final Thoughts on Creditors and Retirement Accounts
Anyone who works in a field that is high risk for uninsured attacks by judgment creditors needs to be careful about how retirement assets are held. For example, rolling over a 401(k) account to an IRA may not be the best idea in some states, because of possible loss of protection from creditors.
Similar concerns can arise if a retiree is offered a choice of receiving a pension benefit in a lump sum.
Bottom line: Get some legal advice from a lawyer in your state about protecting retirement assets before you make a financial planning decision that is irrevocable.