Definition of Bankruptcy Protection for Individual Retirement Accounts
Bankruptcy protection for individual retirement accounts is an arrangement made by Congress that allows owners of individual retirement accounts to shield their accounts from creditors in bankruptcy proceedings.
How Bankruptcy Protection for Individual Retirement Accounts Works
Bankruptcy protection for individual retirement accounts was signed into law during the presidency of George W. Bush under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. This law took steps to protect funds in retirement accounts not tied to employers from creditors by excluding these plans from “bankruptcy assets.”
The Bankruptcy Abuse Prevention and Consumer Protection Act provided the first protections for individual retirement accounts, including those rolled over from a 401(k) plan. Before the 2005 Act, the only retirement plans that received bankruptcy protection were 401(k) plans, pensions, and similar retirement plans provided by employers. The initial protection provided by the Bankruptcy Abuse Prevention and Consumer Protection Act was generally limited to one million dollars.
Bankruptcy protection for individual retirement accounts is quite comprehensive, but some creditors can still claim assets in your account. The Internal Revenue Service (IRS) and an ex-spouse can take money from your account even after you file for bankruptcy.
Example of Bankruptcy Protection for Individual Retirement Accounts
For example, let’s say you owe a significant amount of money and have declared bankruptcy. You have $500,000 in a 401(k) account and $300,000 in a Roth IRA. Your 401(k) account is protected during bankruptcy under the Employee Retirement Income Security Act of 1974 (ERISA), with no limits.
Thanks to the Bankruptcy Abuse Prevention and Consumer Protection Act, your individual retirement account is also protected, up to the inflation-adjusted limit of $1,512,350.
Individual Retirement Account Assets and the Internal Revenue Service
However, there are some cases where your individual retirement account is not protected. If you owe back taxes to the IRS, this federal agency can place a levy on your individual retirement account, in addition to your wages. Generally, the IRS will levy on other assets before your retirement account, but the assets in your retirement account are not off-limits to the agency.
Individual Retirement Account Assets and Divorce
Your ex-spouse can take assets from your individual retirement account if a court orders it. In fact, divorce is the only exception to the rule that an individual retirement account holder must die before their assets can be transferred directly to another person.
A court order may require you to change the beneficiary of your individual retirement account to your ex-spouse if they are to receive all the assets in it. Or the order may require part of the assets in your account to be transferred to your ex-spouse’s account. In either case, the transfer is tax-free as long as it is done according to the terms of the court order.
Judgment Creditors Outside of Bankruptcy
Generally, there is no federal protection for individual retirement account holders who have not filed for bankruptcy. Therefore, the protection of your retirement account from creditors with judgments against you depends on state law, which varies significantly.
For instance, in New York, assets in individual retirement accounts are protected from creditors with judgments against you with some exceptions. A creditor may be able to take money that you deposited into your retirement account within 90 days before they ultimately successfully file a claim against you. They may also be able to take money that a court has decided you deposited into your retirement account with the intent to prevent them from accessing it.
Types
Bankruptcy Protection for Individual Retirement Accounts
Bankruptcy protection for individual retirement accounts covers all types of accounts, including:
- Traditional retirement accounts
- Roth IRAs
- SEP-IRAs
- SIMPLE IRAs
- Rollover IRAs
The limits on bankruptcy protection for traditional accounts and Roth IRAs have historically been adjusted every three years. The adjustment in 2022 raised the limit to $1,512,350 from $1,362,800. The next increase will take effect on April 1, 2025.
Note: The limit on bankruptcy protection for traditional retirement accounts and Roth IRAs applies to the total of all of these accounts, not to each individual account.
SEP-IRAs and SIMPLE IRAs: SEP-IRAs and SIMPLE IRAs are designed for self-employed individuals and small businesses. They receive the same protection as traditional retirement accounts and Roth IRAs, but there is no limit on the amount protected.
Rollover IRAs: The Bankruptcy Abuse Prevention and Consumer Protection Act treats Rollover IRAs as traditional retirement accounts or Roth IRAs that were originally funded through a transfer from an employer-sponsored retirement plan such as a traditional 401(k) plan or a Roth 401(k) plan. Like SEP and SIMPLE IRAs, there is no limit on protection in these accounts.
The financial protection provided for traditional retirement accounts and Roth IRAs covers most account holders because the maximum account balance is higher than what most investors in retirement accounts are likely to achieve from their total contributions and the earnings generated over their working years. Additionally, the Bankruptcy Abuse Prevention and Consumer Protection Act allows for exceeding the protected amount if “the interest of justice so requires.”
Conclusion
When it comes to bankruptcy protection for individual retirement accounts, certain federal rules apply. If you are uncertain whether your retirement account assets are protected in your particular case, consult a legal advisor.
Frequently Asked Questions (FAQs)
How can I protect my individual retirement account from creditors?
You may be entitled to federal bankruptcy protection for your individual retirement account up to the cash limit if you file for bankruptcy. You may also qualify for individual retirement account protection at the state level outside of bankruptcy proceedings depending on the state you live in. Please note that state laws may govern contributions to retirement accounts made within a certain timeframe.
When does a withdrawal from an individual retirement account lose bankruptcy protection?
Withdrawing money during your bankruptcy case can complicate matters. Before withdrawing funds from your retirement account during bankruptcy proceedings, consult your attorney and ensure that the step is approved by the court first. If you are receiving distributions from your retirement account for your retirement, it may be subject to garnishment by the government if you owe federal debts (such as back taxes).
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Sources:
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts in our articles. Read our editorial process to learn more about how we verify facts and keep our content accurate, reliable, and trustworthy.
Sources:
Congress.gov. “Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.”
Federal Register. “Adjustment of Certain Dollar Amounts in the Bankruptcy Code.”
United States Department of Justice. “Tax Division Judgment Collection Manual – 4. Collecting the Judgment.”
Lord
Abbett. “Divorce and Retirement Accounts.”
Nolo. “Can Judgment Creditors Go After My Retirement Accounts in New York?”
Source: https://www.thebalancemoney.com/what-is-ira-bankruptcy-protection-4580359
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