Are Retirement Funds Exempt from Creditors, Including the IRS?

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The bankruptcy code generally exempts certain retirement funds from creditors. It makes sense when you consider why retirement accounts are protected. The government encourages retirement savings by allowing taxpayers to make qualified contributions to retirement accounts on a tax-deferred basis. The tax code is written to ensure that retirement accounts are not used as ordinary savings by penalizing withdrawals from the account until the account owner reaches age 59½. For this reason, the funds held in the account are not accessible and are protected from creditors.

What Retirement Accounts are Protected?

The Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005 offers protection for contributions to and earnings in IRAs, including Roth IRAs, up to $1,000,000. The dollar limit is adjusted every three years and currently is $1,283,025. This applies to all such accounts (not applied per account) and is scheduled to be adjusted again on April 1, 2019.

Company retirement plans that are subject to the Employee Retirement Income Security Act of 1974 (ERISA) are excluded from bankruptcy. The Supreme Court ruled1 that ERISA plans are excluded from an individual’s bankruptcy estate as provided under the Federal Bankruptcy Code2. This protection is provided for an unlimited amount of assets held in plans such as 401(k) and 403(b) company sponsored plans. SEP IRAs and SIMPLE IRAs are not subject to ERISA.

However, BAPCPA states these plans are excluded from bankruptcy for unlimited amounts and are not part of the aggregate total which applies to traditional IRAs and Roth IRAs. Rollover IRAs are also exempt from the cap. Since the funds from rollover IRAs originate from ERISA-qualified accounts, such as a 401(k) or employer pension, a rollover IRA is fully protected from creditors in bankruptcy.

No Federal Protection for Inherited IRAs

The courts have set a precedent of protecting assets from bankruptcy for individuals actively saving for retirement. Retirement assets received by other means have not received the same treatment.
Federal bankruptcy law does not protect inherited IRAs. The U.S. Supreme Court ruled3 that an inherited IRA did not fit the meaning of “retirement funds” protected by bankruptcy:

  • Beneficiaries of an IRA are not permitted to make contributions to the account, they may only take withdrawals.
  • Beneficiaries must begin to take distributions regardless of their age (even though they may be years away from retirement).
    • Withdraw the entire balance within 5 years of the original account holder’s death, or
    • Take minimum distributions (based on life expectancy) until the fund is depleted.
  • Beneficiaries can withdraw some or all of it at any time without a penalty.

It is assumed that the reasoning of the decision also applies to inherited Roth IRAs.

Note: If the beneficiary is a spouse, he or she may secure federal protection. If the spouse rolls over the account to his or her own IRA (or Roth IRA), the funds likely will be treated the same as if the spouse had funded the account. While there have been no cases or rulings on whether this gives the same protection to a spouse as an owner enjoys, there is a good argument for it.

No Federal Protection for Assets from Divorce

A recent appeals court case4 ruled that retirement assets received through divorce were not protected in bankruptcy. The court reasoned that once retirement assets are split from their original owner, creditor protections go away. It is important to note the ruling only applies in the 8th Circuit (Arkansas, Iowa, Minnesota, Missouri, Nebraska, North Dakota and South Dakota). However, it does set a precedent that other districts could follow.

This newsletter has focused mainly on federal bankruptcy protection. IRA owners should note there may also be protection at the state level. For example, a number of states, including Alaska, Arizona, Florida, Missouri, North Carolina, Ohio, South Carolina and Texas, offer their own bankruptcy protection for inherited IRAs.

While an IRA and company plan may be safe from the reach of most creditors, the IRS is the exception. Many people are not aware of this fact, but the IRS can and will levy retirement accounts to satisfy past due taxes. They have the right to demand distribution from a retirement account within the parameters set forth in the retirement plan, even if the taxpayer has not reached retirement age.

Generally, the IRS will levy other types of accounts first and go after retirement accounts only as a last resort. Distributions of any pre-tax money from a retirement account will be taxable, but the 10% penalty is waived when the distribution is caused by an IRS tax levy.

Have additional questions about IRA creditor protection? Contact Rodgers & Associates to speak with a financial planner.

Rick’s Tips:

  • Assets in an IRA and/or Roth IRA are protected from creditors up to $1,283,025.
  • All assets held in ERISA plans are protected from creditors even after they are rolled over to an IRA.
  • Retirement assets are not protected from an IRS levy.

1Patterson v. Shumate, 504 U.S. 753 (1992)

2Section 541(c)(2)

3Clark v. Rameker, 134 S.Ct. 2242 (2014)

4Lerbakken v. Sieloff and Associates, PA, No. 18-6018 (8th Cir. 2018)

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