Bankruptcy and retirement accounts

In a recent article published in Finanial Planning magazine, Ed Slott www.irahelp.com) pointed out that here are differences among retirement lans when it comes to protecting your ssets in bankruptcy and other legal roceedings. Some of these protections ary fromstate to state. Here’s an outline f some of the differences.

RISAprotection: The Employee Retirement Income Security Act of 1974 ERISA) offers the best protection gainst various claims on your assets. Most employer-sponsored plans, such as

01(k) accounts, fall under ERISAguidenes. The law grants unlimited protecon against both bankruptcy and nonankruptcy general creditor claims. For example, assume John establishes contracting business as a sole propritor. He has established 401(k) plans for oth himself and his employees. Assume urther that a client sues John over an ccident associated with his business. The assets in John’s 401(k) remain proected under ERISA up to an unlimited mount. Even if John declares bankuptcy, the assets in his 401(k) are fully rotected. Thiswould not necessarily be he case if the assetswere held in an IRA. Solo 401(k) plans are not covered by RISA. Creditor (non-bankruptcy) proection may be available under state law. However, solo 401(k) plans receive full ankruptcy protection under the bankuptcy code. This is also the case with ther non-ERISA plans, including Simlified Employee Pension plans, simple RAs, non-ERISA 403(b) plans and

57(b) government plans.

RAplans: Traditional IRA and Roth RA contributions and earnings are proected from bankruptcy under federal awup to $1,362,800 now. These limits hange each year based on inflation. However, youmust distinguish between ollovers fromother plans to IRAs. These mits do not apply to rollovers froman RISA-covered plan. If you roll over a alance from an ERISA-covered plan, ou receive unlimited bankruptcy protection for these balances. Slott pointed out that if an owner had a separate IRA account, it is not necessary to separate the accounts to retain the bankruptcy protection; however, it does make sense from an administrative viewpoint to separate the accounts to avoid confusion.

IRA accounts do not have the nonbankruptcy protection associated with ERISA accounts. So if a plaintiff wins a case against an IRA owner and is awarded a judgement, the owner is not protected as hewould be if the account was held in an ERISA account. In this case, state lawdetermines owner protection. For this reason, an owner of an ERISA account should bewary of rolling over an ERISA account to an IRA if there is concern about non-bankruptcy lawsuits. ERISA account owners should discuss such a rollover with an attorney familiar with state lawprotection before using an ERISA rollover to an IRA.

If a 401(k) account is rolled over to another 401(k) plan, itwould retain the non-bankruptcy protection itwould not have if itwas rolled over into an IRA.

Inherited IRAs: TheU.S. Supreme Court has ruled that inherited IRAs are not protected in bankruptcy under federal law.

Timing for protection of assets: Retirement accounts are protected under the bankruptcy laws only as long as the funds are “qualified.” This means that creditors have no access to the funds as long as the funds remain in the retirement account. As soon as funds arewithdrawn, these funds are no longer protected from creditors.

Limited liability corporation (LLC) shield within IRA:

Although IRAs are generally protected from creditors under bankruptcy laws, there are exceptions. A claim can be made against an investment in the IRA. For example, assume an IRA owner owns a business within the IRA, and another person is injured in association with that business. In this situation, the assets in the IRAwould be at risk. However, if the owner had used an LLC to establish the business, hewould be protected.

The bottom line is that the rules associated with protecting retirement accounts are complex, and retirement plan owners should use the advice of their attorneys and/or knowledgeable financial planners in order to protect themselves.

DREAMSTIME